Tahoe Truckee Market Beat: The volatility of the stock market
The stock market goes through cycles of volatility. If you’ve been an investor for a long time, you’ve definitely experienced some volatile periods.
If you’re new to investing or have never invested in the market and are thinking about starting, you should educate yourself about past market volatility and be prepared to go through some volatile cycles in the future.
In the past fifteen years, we’ve seen two fairly dramatic drops in the market; one happened when the dotcom bubble burst and another when the housing bubble burst. Both times, the market lost about half its value. Of course it has since recovered, and this year all the major US indexes have set record all-time highs.
The market spends roughly 85% of the time rising with low or falling volatility and about 15% of the time with falling prices and high volatility. Historical volatility is measured by the standard deviation of price returns.
Another volatility measure that investors hear about often is known as the VIX or volatility index. The VIX is also referred to as the “fear index” because it can be a measure of investor sentiment. The VIX is calculated by measuring the implied volatility of nearby options on the S&P 500 index.
In times of crisis, the options on the S&P 500 will get very expensive as investors and portfolio managers rush to buy portfolio insurance in the form of put options. When the market is quiet and investors are confident, those put options will not be very expensive and the VIX will be relatively low.
The VIX is normally in a pretty tight range; it has only fallen below ten a few times and is normally around fifteen or so. However, it can spike rapidly if the market gets spooked. In the month of October 2008, the VIX opened at 39.39 and hit a high of 96.40, before falling to 59.89 by the end of the month.
Since the VIX tends to rise when markets fall, it can be used as a hedge for stock portfolios. Today there are a variety of investments products available that are related to the VIX including leveraged and inverse exchange traded funds.
Investors need to use caution with these products and really understand how they work before using them. The long volatility products can decay in value over time due to the erosion of the futures prices the funds are based on.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.