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Did Volatility Traders Freak Out Enough To Bottom?

InvestmentWatch

investmentwatchblog.com / BY ·

by Dana Lyons

Yesterday saw a huge spike in stock volatility expectations – but was it enough for a bottom?

One of the great, unintended benefits of financial innovation is the creation of additional market indicators based on the new streams of data. A perfect example is the explosion of stock market-based volatility products. While even the purveyors of such volatility products would likely concede there are enormous potential pockets of risk bubbling up based on investors’ behavior related to the products, that behavior can serve as a valuable indication of investor sentiment – especially when it pertains to fear.

Given the subdued volatility over the past few years, selling volatility has been a profitable strategy probably 95% of the time. It has made for long periods of comfort and complacency for volatility sellers. The problem is, when volatility, i.e., risk, does appear, volatility expectations tend to rise infinitely faster than they dropped. And the theoretically unlimited upside means that those folks who are short volatility are forced to cover, or risk losing everything. These high-fear events are often indicative of some type of a market bottom. Take yesterday’s action, for example.

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