Tuesday, October 28, 2008

Equity Market Finally Rebounds

Seems like the right time for a little perspective:

The above graph takes a look at the S & P 500 over the last 22 years. The right axis looks a bit odd because I wanted to capture the prices swings in relative terms (natural log values). That way, percentage changes appear equal rather than point moves.

Volatility was calculated on a quarterly basis, based on weekly closes. The percentage number on the left axis equals the annualized standard deviation of the index, based on the quarterly move. In other words, if the realized volatility in the most recent quarter were to repeat for a whole year, you would expect that the index would trade between 487.45 and 1,209.71 for 62.87% of the time.

This NOT the same as the VIX that has been mentioned in previous posts. The VIX measures implied volatility for near term, close to the money options on the index. It is the volatility input used in option pricing formulas to arrive at a dollar price for the option.

What is used in the graph is historical or realized volatility. This measure is useful in creating an estimate for implied volatility, but as we know, the past does not fully predict the future.

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