U.S. stock volatility is expected to stay high for rest of year

By Doris Frankel - Analysis

CHICAGO (Reuters) - Volatility is expected to stay the course for the remainder of 2008 and possibly beyond, as stock market gyrations remain the common theme due to fears over the unknown depth of the U.S. economic downturn.

The heightened volatility is reflected in Wall Street's so-called fear gauge or VIX.

The Chicago Board Options Exchange Volatility Index spiked to a record close of 80.86 on Thursday, based on the VIX methodology introduced in 2003 and tracks data back to 1990.

The indicator measures projected stock market volatility embedded in near-term Standard & Poor's 500 index options prices and tends to move inversely to the benchmark.

The VIX pulled back on Friday from its record close and was down to 71.95, off 10.98 percent, while the December futures contract based on the VIX traded at 63.02, down 3.09 points near the close.

"Investors are looking for some resolutions before volatility can possibly calm down," said Andrew Wilkinson, senior market analyst at Interactive Brokers Group in Greenwich, Connecticut.

"They want to see stability in financials and they want to see a resolution in the Congress regarding the automakers. Even then, they are clamoring for a glimmer of hope on the economic front. Until then, I don't think market makers will be willing to command lower premiums for protective options."

High realized volatility for the S&P 500 and new stock market lows have kept the VIX elevated and analysts believe the VIX will stay elevated as long as the dramatic swings in the benchmark persist.

For example, during the last two months, the S&P 500 has averaged an almost 6 percent swing up or down compared to the historical average of 1.17 percent, said Howard Silverblatt, senior index analyst at Standard & Poor's.

"This is totally unprecedented. We are in unchartered waters," he said. "The bottom line is that investors are nervous and concerned regarding the health of the U.S. health economy and their own economic financial well being," he said.

Analysts closely follow the relationship between the VIX and the S&P 500 historical volatility.

The two are linked because the VIX measures the expected volatility of the benchmark over the next 30 days and so past behavior reflected by historical volatility on the S&P 500 will also guide those expectations about future volatility.

The actual volatility for the S&P benchmark is expected to exceed 1929 levels, making the current market the highest sustained volatility environment in the benchmark's history, Goldman Sachs derivatives strategists said on Friday.

In a research note to clients, Goldman said S&P 500 three-month realized volatility, which measures pricing during the past three months, stood at 66 percent, surpassing levels in the 1987 stock market crash and the Depression and is only two points below the level reached during 1929.

The VIX has now closed above the historically extreme level of a 30 reading for 50 days in a row exceeding the 49-day streak set in 1998 as the longest period of extreme implied volatility in the history of the index, said Michael McCarty, chief strategist at broker-dealer Meridian Equity Partners in New York.