Info!! Adding Vision To What Yous Run Into Inward Markets

Strangely, I uncovering that traders who depict themselves every bit visual--i.e., they brand extensive purpose of nautical chart displays of prices in addition to indicators--are with those who merchandise with the to the lowest degree vision.  They brand inferences from what they see; non from an agreement of what lies behind the displays.

Take VIX, the pop stair out of volatility implied yesteryear options pricing, every bit an example.  We powerfulness brand inferences almost whether stocks volition become upward or downwards based upon VIX existence stretched to the upside or downside.  What nosotros know, however, is that VIX tends to displace inversely with index price.  VIX too tends to displace upward or downwards with realized volatility.  So when nosotros human face at a display of VIX, are nosotros genuinely seeing a reading of options-implied volatility or are nosotros seeing a conglomeration of several correlated variables?

To illustrate the point, I built a uncomplicated model of VIX that eliminates the overlapping influence of previous cost elbow grease in addition to recent realized volatility.  This adjusted VIX stair out captures the grade to which implied volatility is high or depression relative to what nosotros would await based upon previous cost elbow grease in addition to realized volatility.  Influenza A virus subtype H5N1 high adjusted VIX way that options are pricing inwards to a greater extent than volatility than nosotros would unremarkably await from the recent cost movement; a depression adjusted VIX way that options are pricing inwards less volatility that nosotros would unremarkably expect.

I went dorsum to 2012 in addition to divided the adjusted VIX into quartiles.  When the adjusted VIX was inwards its strongest quartile, the adjacent v days inwards SPY averaged a hit of +.49%.  When the adjusted VIX was inwards its weakest quartile, the adjacent v days inwards SPY averaged a hit of +.72%.  When the adjusted VIX was inwards its middle 2 quartiles (i.e., when VIX was pretty much inwards trouble with what we'd await from recent cost action), the adjacent v days inwards SPY averaged a loss of -.01%.

In other words, all the market's gains since 2012 tin terminate hold upward attributed to "mispricing" of VIX.  But y'all would never run into that inwards a uncomplicated nautical chart of VIX.  

Trading yesteryear sight does non ever convey vision.

For those interested, the adjusted VIX is currently inwards its lowest quartile, understating the cost elbow grease we've seen recently.

Further Reading:  Pure Volatility
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