Volatility Puzzle

Top Line: A lot can happen in a couple days. The market has certainly denied the head and shoulders top so many were predicting with a resounding rally. The rally shouldn't have too much more to go if any.

We only have time to discuss the volatility index puzzle. With the market running up about 3% across the board on Wednesday, why did the VIX move up by the end of the day? That's a good question and one we are not sure that we have a good answer for but we will give it shot.

INTC (Intel) announced what the market thought was the news of the century so there was a huge rally right away in the morning trade. This caused the VIX to drop from about 26 just before the INTC announcement on Tuesday to just under 24 as the market opened. The last time the VIX was that low was back in early September when the SP500 was right around 1250. This is an extreme condition with bullishness very high.

Some amount of realism needed to come back into the options market and as the day wore on and stocks continued to grind higher and higher, the options traders were pushing premiums up causing the volatility indexes to move higher as well. This is an odd event by itself except that taken in the context of the sheer low level of the index is enough to convince us that the market has not finished its work on the downside.

Taken by itself, the volatility index increase could be very bullish but we now need to see what other indications are going to turn. We expect the market to actually head lower on Thursday morning and we think the Treasury bonds will turn higher after a thorough pounding the last few days. As the rest of the players in the game make up their minds as to what to do, we will then have a clear picture of what's going on.

More on Sunday evening.

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