Sunday, January 15, 2012

Fascinating Indicator - Realized Volatility Premium

Macrofugue posted a chart of an interesting indicator: the realized volatility premium on the S&P 500. (The realized volatility premium is the implied volatility (VIX) minus realized volatility.)

As they put it, "when [the realized volatility premium is] positive, it has presaged increases in implied volatility -- as options writers may have under-priced volatility relative to what has been realised."

If options sellers aren't charging enough - which is what a negative volatility premium means - that is a sign of complacency. It makes sense that these complacent periods are major market tops that precede breathtaking declines.

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