Business - Massachusetts Volatility drops Wall Street's fear gauge sinks to lowest point in 2 years

By Mark Jewell

AP Personal Finance Writer

BOSTON (AP) -- What's not to like about this stock market? It's been steadily rising for more than a month. And it's been the kind of gentle climb that appeals to investors eager for a respite from a couple years of sharp ups and downs.

As stocks have ticked upward from a Feb. 8 low, a measure of the market's volatility has sunk to its lowest level in nearly two years. The Chicago Board of Index Options' Volatility Index -- informally known as Wall Street's fear gauge -- has closed below 17 points for five trading days in a row, and finished Tuesday at 16.35. The last time the VIX closed below 17 was May 16, 2008. It's even slightly below its historic average of around 19 points.

The VIX measures market expectations of volatility over the next 30 days by tracking the prices investors are willing to pay for options -- contracts to buy or sell a stock at a specified price and time. Investors buy options to protect themselves against fluctuating stock prices. When stocks are volatile, investors are afraid, and willing to pay higher prices for options. That raises the VIX.

Lately, investors have become more comfortable that they can predict the market's direction.

"There is just not the demand for the kind of protection that options offer," says Dan Deming of Stutland Equities, who trades options tied to the VIX.

The return to normalcy follows a dizzying couple years that saw the VIX hit a historic closing peak of 80 after the Lehman Brothers collapse.

The index sank into the teens late last year, then briefly returned to the 20s in late January amid fears about Greece's shaky finances and broader worries about the global economy. Now VIX is back in the teens, despite the mixed signals investors continue to get about the pace of economic recovery.

But stocks have been resilient.

"Each time it looks like the market will break down a bit, it's been able to find fresh money," Deming says.

After starting the year on an up note, stocks began falling in late January. The bull market got back on track starting Feb. 9, and the Standard & Poor's 500 has since risen 10.8 percent. That climb has been smooth, with few big one-day swings, and overall the index is up 5 percent for the year.

Deming figures the market's rise is slightly ahead of where it should be, given the uncertainty about the economy as government stimulus measures are withdrawn. For example, a $1.25 trillion Federal Reserve program to buy up mortgage securities is set to expire March 31, which many fear could trigger a rise in mortgage rates.

"The market looks pretty tired," says Deming, who believes the S&P 500 is likely to slip around 5 percent in the next month. "There are certainly areas of the economy, like housing, that need to show some signs of life for the market to really go much higher."

If the market starts to decline, the VIX would likely rise, as investors are willing to pay more for protection from stock swings.

Still, investors shouldn't use the VIX to predict where stocks are headed. A study this month by the market research firm Birinyi Associates didn't find a strong correlation.

The report called the VIX "a coincidental indicator with limited predictive value. It details, perhaps better than other measures, the volatility of the market today, but not tomorrow or the day after."

Published: Thu, Mar 25, 2010