Week in Review - Volatility Reigns!

Volatility Extreme At Historic Levels

Market volatility remains at extremely high levels. The historic average for volatility as measured by the popular VIX index is 30, versus the off the chart levels we see today near 80. The volatility level has been above 30 for 50 straight trading days, which is truly remarkable. But it is also the dramatic swings that we see each day that has investors running to the safety of cash and treasuries! Over the past two months, the daily average percentage change on the market index has been 6% versus an historical average of 1.17% that is almost 5 times the normal level of volatility. There is little doubt that volatility is extreme and at historic levels, as fear runs rampant and drives investor behavior. Turning points usually occur when reliable measures become extreme, and that is where we think the market is now. The critical question is how long will we stay in this period of high volatility and when will it normalize which at some point it will. Market Beating Stocks believes that volatility will remain high at least through the end of the year and likely well into next year. There is simply too much uncertainty and moving parts with regard to financial stability, government intervention programs, the new administration, and other bailout programs. More time is needed for the storm to settle, and consumers have to begin to feel safer when it comes to their jobs and financial assets.

Market Beating Foresight

Next week, economic reports will be released on existing home sales, consumer sentiment, and weekly jobless claims which will further weigh on the market, along with a Black Friday that carries a bleak forecast. The viability of Citigroup is being tested as the share price falls below $4. Government intervention may be necessary to avoid a failure, concerns that certainly trouble the financial sector. As we have said before, we think that volatility will remain very high over the near term. However, we also believe there are signs the market has reached extreme levels in volatility, interest rates, and equity valuations, levels that usually represent turning points. Are we at the bottom? No one can predict, but we may have hit bottom on Thursday last week, but as investors you do not have to worry with calling the exact bottom. Market Beating Stocks believes we are at a trading range bottom based on extreme volatility levels, near zero treasury interest rates, and compelling equity values following market losses nearing 50%. Are there ways to profit in this environment? Fear and risk aversion is very high which drives up the price investors pay to manage risk. Now may be a good opportunity to play the volatility in your favor by trading options, particularly writing puts in spread positions. However, if investors write puts, they really need to limit their risk on the downside by purchasing a put option a little farther out of the money than the one sold. We are also going to look for more short term trading opportunities with the market indexes to take advantage of large daily price swings. Over the past two months, the market index has averaged price swings of 6% per day and that is truly amazing. We are going to look for an opportunity to buy both a call and a put on the market index with the same exercise price. If we can get in with reasonable premiums, the plan would be to hold only for few days, hoping to take advantage of a 5% market swing eventually in both directions. Granted, it may take a few days to get the second swing, but if trading patterns continue, the current volatility and average price swings we have been experiencing will give us a very good chance.