Highlighted stocks include Bristol-Myers Squibb (BMY), Kimberly-Clark (KMB) and General Dynamics (GD). Also mentioned is the S&P 500 (SPX).
The markets continue to experience unusual volatility. This can be seen in the CBOE Volatility Index (VIX), which set record highs yesterday.
The VIX calculates the expected stock market volatility for the next 30 days. The indicator accomplishes this by using a weighted average of implied volatility from S&P 500 (SPX) index options contracts. Specifically, the VIX looks at options for the 2 months closest to expiration, which is currently November and December. (October contracts expire today and are no longer factored into the indicator.)
Options prices are based on a combination of risk-free interest rates, expected changes in the price of the underlying asset and time to expiration. The more the price of a stock (or index) is expected to change in the near-term, the higher the amount of volatility an option contract is going to price in. In other words, the more volatile a stock price is, the more its options contracts are going to cost.
Volatility increases the cost of an option contract, because there is a greater likelihood that the contract will expire 'in the money'. At expiration, a trader can exercise his right to buy, or in the case of a put - sell, the underlying asset at a fixed price. Alternatively, he can let the option contract expire worthless. Obviously, if a trader can buy a stock for less than its current price or sell it for more than its current price, he will do so.
The more one thinks an option is going to be valuable at expiration, the more he is going to pay for the contract.
In the case of the VIX, traders are fearful that the S&P 500 is going to have more large swings over the next two months. Therefore, they are paying more for options contracts. Simply put, they expect to exercise their options contracts at expiration. In a falling market, this is bearish, because traders are essentially betting on a further decline.
Is The VIX Calling For A Rally?
The VIX is a contrarian indicator, however. A study by Credit Suisse found that, after adjusting for market drift, high VIX levels correctly predicted a 5-month rally 63% of the time. Given that the indicator is at record levels, it is essentially calling for one heck of a forthcoming rally.
This is partially why some market observers believe that now is a buying opportunity for investors.
Before anyone goes out and bets the farm, however, I should state that there continues to be real economic problems. Though the freeze on credit is starting to thaw, short-term credit remains very difficult to secure. More jobs will be shed and an unemployment rate in the high single digits is within the realm of possibilities. Consumers are tightening their budgets. A higher number of home foreclosures and credit defaults will occur. Demand for exports will be weaker in the months ahead.
Not to mention, the trend in earnings estimates for 2009 is negative.
Nonetheless, the selling has been indiscriminate. Shares of many fundamentally sound companies have been knocked down for no rational reason. Examples include Bristol-Myers Squibb (BMY), Kimberly-Clark (KMB) and General Dynamics (GD).
Read the full analyst report on BMY
Read the full analyst report on KMB
Read the full analyst report on GD
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