Nasdaq 100 smiles during market frowns

Every now and then you just have to accept you do not understand something. In your correspondent’s case, trading a volatility index or a derivative thereof when you are motivated by a price opinion falls into that category. If you think the market is going to go down, there are plenty of price-based futures, options and exchange-traded funds capable of executing your opinion precisely and with a well-behaved and liquid instrument. Going long volatility instead recalls a long-ago comment made about self-impressed slugger Reggie Jackson: “There isn’t enough mustard in the whole world to cover that hot dog.”

Some volatility-based products are very successful trading instruments indeed, and volatility patterns are useful in market analysis, particularly in sniffing out relative anxieties between buyers and sellers. The CBOE Volatility Index (VIX) can be discussed in terms of time-adjusted retracement of gain and proximity to last new low price in the market, both of which reflect traders’ psychological regrets over loss and fear of further losses (see “Balancing fear and greed,” September 2003).

Nasdaq 100 volatility

If the S&P 500-based VIX is not hot enough for you, or if you find the trading-hour misalignment between the Stoxx 600-based VSTOXX and the VIX challenging, then consider the Nasdaq 100-based NDX volatility index, or VXN. The differences between the S&P 500 (SPX) and the Nasdaq 100 (NDX) in terms of both historic and implied volatility are obvious to anyone who has traded them, and the sector composition of the two indexes creates a potential for rapidly moving spreads.

Rather than focus on these differences or even on the different responses of the VXN to the NDX when compared to the VIX-SPX relationship, let’s focus instead on some signals generated by the VXN. 

First, let’s map the VXN-NDX relationship over the post-February 2001 history of the VXN not as a function of time but rather of price. Each vertical line in “VXN Shock & Regress” (below) represents a day’s high-low range in the VXN, mapped on a logarithmic scale, against the day’s closing NDX level. Two cubic trend curves through the VXN highs and lows are superimposed.

Two dates are marked: The March 5, 2014 post-dotcom bubble high in the NDX and the April 7, 2014 reaction low associated with a selloff in the technology and biotechnology sectors. The 5.89% pullback in the NDX looks very small indeed. The 4.83-point increase in the VXN over the same period is in line with previous experience.

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