November 4, 2008 / 7:33 PM / 9 years ago

Fear index fades as US stocks rally on election day

4 Min Read

CHICAGO, Nov 4 (Reuters) - An index regarded as Wall Street's main barometer of investor fear dropped sharply on Tuesday as U.S. stocks rallied on election day.

The Chicago Board Options Exchange Volatility Index, commonly called the VIX .VIX, dropped 10.88 percent to 47.84 after posting a session low of 44.25.

Volatility has now contracted significantly after setting a record high of 89.53 in the turbulent month of October.

"The VIX is down because the market loves certainty and within 24 hours, we should know who our next president will be," said Joe Kinahan, chief derivatives strategist at Chicago-based online brokerage thinkorswim Group.

But he noted the VIX is still at an historically high level as a change in leadership is not expected to immediately wipe out concerns about the U.S. economy's health.

"We still have economic problems. But the biggest difference is that the fear of a total financial system collapse has been mitigated," Kinahan added.

U.S. stocks climbed as investors picked up shares trading around five-year lows amid further signs of easing in credit markets.

The broad Standard & Poor's 500 Index .SPX shot up 3 percent to 995.72, near its session high, in mid-afternoon trading. The Dow Jones industrial average .DJI gained more than 200 points, or 2.4 percent, to 9,539, while the Nasdaq Composite Index .IXIC shot up 2.4 percent, or 41 points, to 1,767.36.

A lot of stocks that have been beaten up in the market's steep decline of the past couple of months have shown good resilience, analysts and traders said.

"They seem to be absorbing any additional selling and recovering very quickly," said Herb Kurlan, chief executive of Vtrader Pro, a proprietary online trading firm in San Francisco.

Better Credit Markets Expected

The VIX measures projected stock market volatility embedded in near-term Standard & Poor's 500 index options and typically runs inversely to the S&P benchmark.

It tends to fall when investors are more complacent about current stock levels and as a result, they are more likely to reduce option hedges as a way to offset stock market risk.

"There is a sense that there will be more stability in trading for the rest of the fourth quarter," said Scott Fullman, director of derivative investment strategy at broker-dealer WJB Capital in New York.

"It appears that options are being priced for lower risk and lower perceived volatility following the U.S. presidential election due to the expected improvement in the credit markets," Fullman said.

At a 46 reading, the VIX is significantly below the near-term actual volatility level of 84.2 percent for the S&P benchmark, said Frederic Ruffy, options strategist at New York-based Web information site WhatsTrading.com.

"The big difference between the 20-day actual volatility and the current readings from the VIX seems to reflect a sense of growing optimism among investors," Ruffy said. "This is probably due to the fact that November and December are months that are historically a lot less volatile than October."

Investors believe there is not a rush to own put options to protect their portfolios, which translates immediately to a significant drop in volatility as measured by the VIX, Vtrader's Kurlan said.

Another notable sign: During Tuesday's session, the cash VIX hit a level that was below the front-month November VIX futures contract on the CBOE futures exchange. In afternoon trade, November VIX futures stood at 46.49 after hitting a low of 43.80.

"That's the first time since early September that the premium has shunk to parity with the future. We had been up as much as 24 points over the future, so this is record shrinkage," said Jon Najarian, on his Web information site optionmonster.com. (Reporting by Doris Frankel; Editing by Jan Paschal)

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