Wednesday, March 2, 2011

"Charting the VIX: Does Technical Analysis Work?" (VIX; VXX; VXZ)

It had better.
Fundamental analysis doesn't.
Tea leaves?
Chicken entrails? Tried that during the World Cup, learned "Don't bet the over in soccer no matter what your 'gut' feel is".

Here's Options Insider:

You can view a chart of the VIX just as you can for any stock. Just enter the symbol, add some moving averages, maybe even some Bollinger Bands and RSI indicators and you’re on your way.
In fact, here’s a chart of the VIX going back about six months (as of February 23) with a simple 20-, 50-, and 200-day moving averages overlay.

It may look like a stock chart – and may even appear to be finding resistance at the 200-day moving average.

But just because you can chart the VIX just like a stock, doesn’t mean you should actually read the chart just like a stock.

If you use technical analysis tools to study stocks, you probably use a variety of tools to evaluate various support and resistance points. These represent actual buying and selling over specific timeframes. Stocks gap up and down. Gaps get filled. Old resistance points can become new support levels, etc.
So why doesn’t this seem to translate to the VIX?
First, the VIX isn’t a stock. It’s an index of implied volatility (IV) for S&P 500 options – weighted to represent the IV for at-the-money SPX options that with a theoretical expiration of one month.
But “price points” for the VIX don’t correspond to potential profits and losses of actual trades based on those levels.

Volatility: Just one moving part
The implied volatility of any option is but one moving part of a complete transaction. Let’s look at an example. If I purchase an at-the-money SPX straddle (both a put and a call – a multi-leg transaction that adds to commission costs) with the VIX at 22, the S&P might rally. Even if volatility plummets back to 16 or lower, my straddle could be profitable if the rally is high enough.
Or the market could fall. Volatility may soar, but my straddle might still lose money if the market doesn’t fall far enough.

My point is simply that the VIX you see on your chart does not correspond to profits and losses in nearly the same direct way that it does for a stock....MORE