We asked our friend on Wall Street to make a summer forecast and to explain a term we're hearing a lot on the news these days: the "volatility index," or the "VIX." Here's the report. -- DL
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You asked about the stock market going into summer as shaky as it has been for, what, four years now? But the entire premise of the stock market is that there is no end in sight, and if there is, it's only because you're facing the wrong way. No matter how many times it's right, and so far it's always been right in the U.S., it only has to be wrong once and it's gone forever, or at least until the next stock market shows up. What happened to the ancient Greek and Roman stock markets? The Aztec and Inca stock markets? The U.S.S.R, East Germany, and hardcore Communist China? They all became mature markets of one kind or another, and top heavy, and toppled. We may be headed in the same direction, at least financially, which is why diehard investors, if they haven't given up on equities altogether, even the risk takers mired in biotech and IT, are so infatuated with emerging markets right now. No unions? No EPA? Heck, I might actually make money in those countries, and what I don't know about the poverty and the torture, well, let's drop that thought right there. And they're right, they might make money there, some foreigners do, but they shouldn't expect any investment protection that they don't provide themselves. The SEC stops at the same border so many people fleeing from emerging markets cross on their way into the States. Why do they think rich Brazilians and Mexicans have armed bodyguards?
No one knows what's going to happen next, anywhere, and at this point it seems like it's going to be this way for a while, with market volatility registering every swing up, down, and sideways in the national and international psyche. Fortunately, you can invest in this volatility, and when a friend's cousin told me how he was doing it, I realized at once that he was investing in the closest thing to a sure thing we've seen in a long time. The VIX, as you may know, is the CBOE's volatility index for the S&P 500—and you can take positions not only in the options of the index itself but also in other derivative products, including ETFs, depending on where you expect the index will be, or not be, in the next 30 days. When I asked Richard where he put his money during lulls, he said, "In my pocket"—that is, he was either making a specific time bound trade or he was out of the market altogether. No, he isn't contributing to the GDP, but he's not loafing in blue chips, either.
A couple of things worth thinking about before you call your broker. Wikipedia: "The VIX is the square root of the par variance swap rate for a 30 day term initiated today. Note that the VIX is the volatility of a variance swap and not that of a volatility swap (volatility being the square root of variance). A variance swap can be perfectly statically replicated through vanilla puts and calls whereas a volatility swap requires dynamic hedging. The VIX is the square root of the risk neutral expectation of the S&P 500 variance over the next 30 calendar days. The VIX is quoted as an annualized standard deviation." The second is from Rubashov's diary in Arthur Koestler's Darkness at Noon: "The capitalist system will collapse before the masses have understood it.
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