VIX Declines Below 40 as ‘Sheer Panic’ on Wall Street Recedes

By Jeff Kearns

Dec. 31 (Bloomberg) -- The benchmark index for U.S. stock options dropped below 40 for the first time since Oct. 2 as stocks climbed a second day and traders bet that this year’s record equity market swings will ease.

The VIX, as the Chicago Board Options Exchange Volatility Index is known, dropped 3.9 percent to 40 and fell as low as 37.96. The index measures the cost of using options as insurance against declines in the Standard & Poor’s 500 Index, which added 1.4 percent to reduce this year’s loss worst loss since the Great Depression to 38 percent.

“Going above that number was a really big indicator of sheer panic,” Dominic Salvino, a specialist at Group One Trading, the primary market maker for VIX options, said regarding the VIX exceeding 40 in an interview from the CBOE floor. “The market’s starting to stabilize a little bit.”

The gauge, known as Wall Street’s “fear gauge” because it almost always rises when stocks drop, measures expectations for volatility over the next 30 days. It fell 51 percent after closing at 80.86, the highest in its 18-year history, on Nov. 20 as the S&P 500 fell to an 11-year low. The VIX averaged 16.13 in the five years before 2008.

Stocks gained after fewer Americans filed for jobless benefits and the Treasury said it will expand aid to the car industry. The S&P 500 has rebounded 20 percent since its low last month.

VIX Futures

The second-most-active options on the VIX were January 40 puts, which added 53 percent to $2.60 and accounted for almost a sixth of the 17,550 puts traded today. January VIX futures lost 5.1 percent to 41.94. March futures slid 4 percent to 40.41.

“Volatility in the high-to-mid-30s and the 40s is what we’re going to be left with,” Steve Claussen, chief investment strategist at OptionsHouse LLC, the Chicago-based online brokerage unit of PEAK6 Investments LP, said in a Bloomberg Radio interview. “That implies a 2-percent-a-day move in the S&P, and I think people would look at that now and say ‘Wow, the markets are calm.’”

The CBOE’s NDX Volatility Index, based on prices paid for options on the Nasdaq-100 Index, fell 2.1 percent to 40.79, the lowest level since Sept. 26. The Nasdaq-100, which get 59 percent of its market value from technology companies, rose 0.9 percent.

Investors use options to guard against fluctuations in the price of securities they own, speculate on share-price moves or bet that volatility, or stock swings, will increase or decrease.

To contact the reporter on this story: Jeff Kearns in New York at jkearns3@bloomberg.net.

Last Updated: December 31, 2008 16:53 EST