Time and time again this blog attempts to point out flaws in the VIX. Today, we saw a classic example that Option Pit Mentoring argues can cause the VIX to be misleading. The the VIX closed down .13%, but did implied volatiltiy really fall (follow the charts below):
Above, we can see the VIX was in fact down. Now take a look at the IV of the ATM option (the 1335's) yesterday (2/16/2011):
The IV is 13.17%. Here is that same strike today:
Notice, the uptick in implied volatility on that particular strike. This uptick is not unsubstantial at over .25 point.
This is a classic example of how the sensitivity to changes in underlying price can screw up the reading the VIX reports. If we look at every strike across within 10 strikes of at the money in the SPX, their implied volatilities were up today. This is an important lesson to both spec and income traders. One might look at a fly, a condor, or a credit spread and wonder why they are losing money today; it is because the VIX is telling the trader the wrong thing, VOL WAS UP!
The point of this: Look at the months and strikes you plan to trade, write down what the volatilities when you enter a trade, and look at the IV's of your position for explanations...not some abstract number developed by mathematicians.
PS if you think this is interesting, check out the blog about VIX methodology and the individual equities.
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Graphs from LiveVolPro