08.02.2011
By Terry Flanagan

Volatility Seen Persisting

The Chicago Board Options Exchange’s Market Volatility Index (VIX), which measures the implied volatility of the S&P 500 index, has risen sharply in recent weeks, spurred by the prolonged uncertainty surrounding the U.S. debt ceiling and the lengthy negotiation process. But even though a deal was finally struck on July 31, increased market volatility is expected to continue.

“The longer this thing lingers, the more structural damage is caused to the U.S.’ financial position globally,” Daniel Deming, senior trading managing partner at Stutland Volatility Group, told Markets Media on July 29. “It will increase volatility for the rest of year.”

While the threat of a U.S. debt default has passed for now, there are still other implications of the nation’s burgeoning debt-to-GDP ratio, including a potential downgrade of its triple-A credit rating. “They pushed it too far,” Deming said of the extensive negotiations. “They still might get downgraded.”

The VIX, commonly known as the ‘fear gauge’ of Wall Street, soared more than 50 percent over the final three weeks of July to four-month high of about 24. Aside from the U.S. debt situation, the ongoing sovereign debt issues in the Eurozone also played a role.

Deming asserts that although the VIX rose to levels last seen following the March earthquake in Japan, the S&P 500 index, on which it typically has an inverse relationship, has remained relatively steady. Usually, when there is a sharp increase in the VIX, there is a sharp drop in the S&P, and vice versa.

As far as where the volatility index is headed for the remainder of the year, Deming believes that the next few weeks will be telling. In the weeks leading up to the debt deadline, the market had performed “extraordinarily well, holding up in the face of bad news,” he noted.

Deming said that the next issue will be how much the entire process will affect the next round of corporate profits. Either way, Deming expects to see the VIX stay at an elevated level for the short term, as the VIX’s current mark already factors in that a downgrade is coming. “There is a mindset that we may have lowered a notch in the global view as a financial leader,” he said.

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