Erin Go ….Throw Out Some Stats

• Posted by Adam Warner
• on March 17th, 2010

So I’m reading The Book: Playing the Percentages In Baseball. I’m not big on the whole as is Moneyball so is Investing analogy, but the stats in this book concepts are strikingly similar to ours. It’s all standard deviations and confidence ranges and the like.

And a couple concepts they emphasize over and over. Context and sample size. Stats are only meaningful in context. Was watching Ranger game last night and the Canadiens score first, and Versus pops on that the Habs are 24-7-1 when scoring first. Sounds great in a vacuum, but what if the league as a whole wins 75% of the time when they score first? The stat becomes kind of meaningless.

These are things you likely understand without me. Or not. This, from the Journal yesterday.

The CBOE Volatility Index, or VIX, Wall Street’s favorite “fear gauge” is at 17.56. If it closes there, that’d be second-lowest level since Jan. 19, when it closed at 17.58. Market watchers will remember that it didn’t stay that low for much longer. The market suffered a steep falloff soon after, most notably the S&P 500’s 2.2% tumble on Jan. 22. At the same time, the VIX surged back up to more than 27.

That’s not to say, we’re definitely due for a fall. The VIX isn’t a great predictive tool. But it is a sign that complacency might be seeping into the market. And that could make a negative catalyst a potentially stinging surprise for sleepy investors. “When you have a VIX hanging down here, if something goes wrong it could accentuate the pain,” said said John Schlitz, Instinet’s chief U.S. market technician. “It could intensify it.” Take heed traders.

OK, what’s missing here? Hint: I gave the clues just above.

There’s no context. Like how about the fact that the VIX estimates proxies SPX volatility going forward 30 days, and 17.5 is actually quite high compared to recent volatility of SPX itself. If the VIX was 17.5 amidst a jittery market or we were expecting big news, then this might look very complacent.

And there’s a word of market caution based on a sample size of …..1 instance. I call that coincidence until proven otherwise. VIX down 1 from there today anyway.

But there is a good point tucked in here. The market technician speaks the truth. The lower the VIX (or any volatility measure) the less cushion for an outlier. A VIX of 16 prices in about a 1% range in SPX. That’s more or less the breaking point beyond which options shorts would start chasing. So if you start seeing days beyond that threshhold, it can feed upon itself. The main point being at 17 VIX, that threshhold is much lower than say, 27 VIX.

Again though, with realized volatiltiy of 7, it’s party time for options shorts. For now.

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