Saturday, November 1, 2008

VIX vs S&P 500 & LTCM

They don't call the VIX the fear factor for nothing =)
This graphic is from

Notice the symmetry... so one might dare guess that when the VIX is nice (read: low relatively speaking) and quiet... that it may be the calm before the storm, something is about to blow up.... a theoretically good strategy may be to put all your $$$ into Treasury Bills.... then when the VIX spikes in another 10 years because of some massive kick in the face.. take your super low risk loot and buy the hell out of some solid companies.. Warren Buffet style (buying solid stuff at a deep discount.)

For recent kicks in the face, think... the 1987 crash, the Dot Com Crisis, and then later the almost catastrophic LTCM fiasco.

Rough Summary of the wiki link.

LTCM was basically a hedge fund that had a position of $1.25 TRILLION (notional value) in derivatives... Board of Director members include Myron Scholes and Robert Merton... of Black-Scholes-Merton option pricing Nobel Prize fame. It got totally pwn3d when Russia decided to say F@#$ YOU to everyone and default on their Government Bonds (this was circa 1998)...... LTCM was particularly exposed to this type of event. Since the % gained from its technique was relatively low.. they required massive leverage near the range of 25 to 30 to 1. These events resulted in LTCM losing $4.6 Billion in less than four months...

BTW the LTCM crisis may look familiar because it appears that it set a precedent for bailing out financial institutions... The Federal Reserve Bank of New York organized a $3.625 billion bailout (by other institutions) to avoid a wider collapse... some think that this opened Pandora's box for future dependancy on the idea that the Federal Reserve would have your BACK when you got punched in the face...

For more about 'When Genius Failed'.. check this out.

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