Volatility Analysis
When the market expectation is bearish, for example, this will spark a flurry of
traders and investors buying puts and selling calls. On the contrary, if the mar-
ket expectation is bullish, traders and investors would instead be buying calls
and selling puts. If such activity is significant, the readings in the VIX will rise. A
very high VIX reading is normally seen as an early warning of a market bottom.
Figure 21.25 shows the inverse relationship between the VIX and the S&P500
Index.
Another popular measure of market volatility is the Put‐Call ratio, which
tracks the premiums and volume of puts against calls. In a bearish market, the
put‐call ratio is normally much higher, as more investors and traders attempt to
protect their portfolio asset values in a falling or plummeting market. At historic
highs in the put‐call ratio, a potential market bottom is expected.
One question that many practitioners ask is whether volatility provides any
indication of future market behavior or direction.
Volatility cycles can be seen in the markets on a daily basis. Figure 21.26
below show a 15‐min chart of the USDCAD currency pair. Each vertical line sepa-
rates one day from the next. We clearly observe regular and fairly consistent cycles
in ATR, volume, standard deviation of average price (via the Bollinger Bandwidth
Indicator), and trend action (via the ADX indicator). Therefore, volatility does
provide forecastable market behavior in the form of consistent cycle action. Afigure 21.25 Volatility Cycles on the 15‐Min USDCAD Chart.
Courtesy of Stockcharts.com