What to Make of the Rising “Fear Index”

by Robert Williams, Contributing Editor
Monday, October 5, 2009

The Chicago Board of Options Exchange Volatility Index (^VIX), also referred to as the “Fear Index,” spiked by over 30% in last week’s trading.

The VIX tracks prices investors are willing to pay for options on the underlying stocks of the S&P 500, often to protect against drops in the market. The higher the demand for such instruments, the higher the prices go.

Thus, the principle idea is that rising premiums on options (puts and calls) can be directly associated with increasing anxiety levels among traders. (The benchmark for absolute panic is the 89.53 reading logged on October 24, 2008 – at the height of Wall Street’s meltdown.)

So given the recent surge in the VIX – from 22 to near 30 – should we be running for cover?

Absolutely not.

Late September and early October is a historically rough-sledding time for stocks. Think of it as a collective exhale, as Wall Street institutions and traders alike reflect on the year’s price action. And ultimately decide how best to play the home-stretch run.

We’ve pushed stocks a long way off those infamous March 9 lows. Heck, the price-to-earnings ratio on the S&P 500 actually sits higher than it did before the crash.

But as long as companies beat analysts’ watered-down performance expectations in the coming earnings season, we’ll be fine. In fact, a favorable batch of earnings would likely set the stage for a year-ending Santa Claus rally.

Ahead of the tape,

Robert Williams

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