VIX & DVAX
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VIX is implied volatility as derived from CBOE options prices relative to underlying S&P 500. High VIX levels are generally taken as indications of investor anxiety (often following price declines), and interpreted as "contrarian" indication of likely advance. conversely, low VIX is generally taken as indication of probably weakness.
But VIX has a problem in being non-stationary. There is no benchmark for how high is "high" or how low is "low." What seemed "low" a year ago seems "high" today. Here is a picture of the VXO (which is the "old" version of VIX, and is virtually indistinguishable form it).
|VXO ("Old" version of the CBOE implied volatility index) is non-stationary...|
Normalizing VIX for cross-sectional market dispersion removes much of the high-low uncertainty, giving a more stationary range of variation. Dispersion is measured by our daily DVAX index, which is an estimate of annualized cross-sectional standard deviation of daily returns from a very broad sample of stocks. Here is a chart of the VXO/DVAX ratio*:
|Ratio of VXO/DVAX has a more stable range...so we can see "highs" and "lows"|
|July 1 Update: Ratio at .3999 (7th Percentile)|
(*) The actual ratio plotted here is VXO/DVAX rather than VIX/DVAX. The CBOE has substituted a "new" VIX and VXO is the designation for the traditional version. In actuality, the VIX and VXO are almost indistinguishable and either one serves equally.