Over the past few days, volatility has exploded, but the decline in the Standard & Poors 500 Index ($SPX) has been muted. This is unusual, but not completely unprecedented. We’ll take a look at what this might mean for movement in the broad market, as well as why this is happening. As you might expect, there is more than one theory about what’s causing this aberration.
Well get into the nitty gritty details shortly, but let’s describe what’s happened, briefly. In the past three days, $VIX has risen a whopping 49%, while $SPX has fallen 1.9%. That is a huge differential. Statistics show that the past 20 times that $VIX has risen by more than 40% in three days, $SPX was down 5.3% on average. So this is a very extreme case.
One way or the other, market makers and other “dealers” have been caught with massive short volatility positions. While they might not be directly in the $VIX futures, when one is faced with a short $VIX position, he can either close it out or can hedge by buying $VIX futures. There is a lot of that going on right now...
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