Fear index fades as U.S. stocks soar on Election Day

CHICAGO (Reuters) - An index regarded as Wall Street’s main barometer of investor fear fell sharply on Tuesday as U.S. stocks rose in an Election day rally.

The Chicago Board Options Exchange Volatility Index, commonly called the VIX, was down 11.08 percent to 47.73 after falling as low as 44.25.

Volatility has now contracted significantly after the index spent most of the turbulent month of October above the 50 level. It was near a 40 reading on October 1, but quickly moved above 50 by October 6 and hit a record intraday high of 89.53 on Oct 24.

But on Tuesday, the VIX made a decisive move below 50 in a sign the market is pricing in a dramatic change in the volatility landscape when compared to the market action in October, said Frederic Ruffy, options strategist at New York-based Web information site WhatsTrading.com.

This might be due to the fact an important event risk -- the U.S. Election -- will soon move to the background. “In addition, credit markets have been easing for almost three weeks and global equity markets are stabilizing,” Ruffy said.

“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.

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, 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 tracks projected stock market volatility embedded in near-term Standard & Poor’s 500 index option prices and typically moves 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.

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.