RPT-UPDATE 2-U.S. options fear gauge soars to record close

Mon Oct 6, 2008 5:54pm EDT

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(Repeats to add dropped word "to" in 2nd paragraph to read ...up 15.31 percent to 52.05.) (Updates VIX closing levels in paragraph 2, adds analyst comments in paragraphs 10-15).

By Doris Frankel

CHICAGO Oct 6 (Reuters) - An index regarded as Wall Street's fear gauge surged to a record close on Monday as investors clamored for protection in anticipation of more stock market turmoil on worries over the widening credit crisis.

The Chicago Board Options Exchange Volatility Index .VIX, or VIX, surged to a record high of 58.24 before easing back to close up 15.31 percent to 52.05.

"This is absolutely amazing. The elevated VIX is reflecting that people are unsure about every financial relationship they have ever known not only in the U.S. but worldwide," said Joe Kinahan, chief derivatives strategist at thinkorswim Group.

Persistent strains in the credit markets added to nervousness about the wider economic outlook, while a spate of bank rescues in Europe heightened worries about the stability of global financial institutions.

"Not only are the U.S. banks in financial trouble but it appears that the European and foreign banks may be in worse trouble due to the credit crisis," Kinahan added.

The Dow Jones industrial average .DJI dropped 369.88 points to fall below 10,000 for the first time in four years. The Standard & Poor's 500 index .SPX fell 3.85 percent to 1,056.89.

The VIX, which reflects investors' consensus about anticipated stock market volatility over a 30-day period, tends to move inversely to the S&P 500 benchmark, and spikes upward when the market posts sharp losses.

The record level in the VIX on Monday reflects a change in the index made by the CBOE in 2003 to provide a more precise reading on stock market conditions, basing the index on the prices of the more popular S&P 500 options.

The old VIX, introduced in 1993, is based on S&P 100 options, a smaller basket of stocks. That index, the VXO .VXO ,also hit a multiyear high on Monday, closing up 14.95 percent at 59.50, after scoring a new peak of 66.42.

"With today's high on the VXO of 66.42, it is safe to say the uncertainty now exceeds all times in recent history, with the exception of the crash of 1987 when the old VIX hit 150.19 briefly and remained above the current levels until about Oct. 29, 1987," said Randy Frederick, director of derivatives at Charles Schwab in Austin, Texas.

From a contrary view of the markets, the spike in the VIX is possibly a sign that investors have overreacted and the equity market is oversold.

But being a contrarian during the recent stock market decline has not been a winning strategy, said Frederic Ruffy, options strategist at website WhatsTrading.com.

He noted each time the VIX moved above key levels at 30, 40 and 50 readings, the stock market experienced a short-term bounce but the rally proved to be short-lived and the S&P 500 eventually faltered, falling to new lows.

Volatility remains exceptionally high and with the ongoing problems in the credit markets, many would-be buyers are likely to remained sidelined, Ruffy added.

"After being burned so many times during the recent market decline, very few investors are going to dive in and try to catch the absolute bottom," Ruffy said. "Instead, they might wait for signs that volatility is indeed falling and that stocks have found a solid leg to stand on." (Reporting by Doris Frankel; Editing by Leslie Adler)

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