Week of August 3, 2010

Over 80 % of the time the relationship between the CBOE Volatility Index (CBOE: VIX) and the Standard & Poor’s 500 Index (SPX) is an inverse one. That close relationship does not mean that we can determine a particular price in the SPX by using a corresponding price in the VIX. Let’s compare the 2009 prices of the VIX to similar VIX prices in 2010, and how they correspond to prices in the SPDR S&P 500 ETF (NYSE: SPY), the exchange-traded fund that closely reflects the price of the SPX.

On April 15^th, 2009 VIX closed at 36.17 while SPY closed at 83.52. VIX historically trades around 10% of the value of the SPX, but there was a great deal of uncertainty – and therefore volatility – in last spring’s falling market. On April 27^th, 2009 the VIX closed at 38.82 while SPY closed at 84.10. On May 24^th, 2010 SPY closed at 107.20 while the VIX closed at the same 38.82 level from April 27^th, 2009. Different markets going in different directions but identical VIX levels. Here are some more examples:

On May 7^th, 2009 the VIX closed at 33.44 with SPY closing at 91.09. On June 8^th,2010 the VIX closed at 33.70 with SPY closing at 106.12.

On May 20^th the VIX closed at 29.03 while SPY closed at 88.67. On June 11^th, 2010 the VIX closed at 28.97 while SPY closed at 109.16.

On June 30^th, 2009 the VIX closed 26.35 while SPY closed at 90.59. On July 16^th, 2010 the VIX closed at 26.25 while SPY closed at 106.66.

On August 3^rd,2009 the VIX closed at 25.56 while SPY closed at 98.86. On July 21^st, 2010 the VIX closed at 25.64 while SPY closed at 107.07.

The price level for SPY is approximately 20% higher in 2010 than it was in 2009, but as you can see we have similar levels in the VIX. How much the investor benefits from VIX exposure is very volatile itself. Bullish portfolio definitely benefits with a positive VIX exposure, due to the inverse relationship between the VIX and the overall market. Normally there is more demand for options in a down market because the VIX can be looked at as a measure of the amount of time value that is embedded in SPX options.So why is the VIX so much higher, relatively speaking, than it was last year?

Part of it is probably the up and down nature of the market this year. Investors don’t seem to be trusting this year’s rallies. Fear has not been stamped out. If the market continues to rise at a steady rate the VIX will probably return to historically normal levels.