Fear index hits new lows as jitters ease

MARKET optimists and bulls breathed a sigh of relief this week when the CBOE&rsquo;s Volatility Index &ndash; the so-called &ldquo;fear gauge&rdquo; &ndash; reached its lowest levels since Lehman Brothers collapsed last September. While a recovery is far from assured, the calmer Volatility Index suggests that more settled times may be ahead for the equity markets and that talk of green shoots may be partially justified.<br /><br />The Vix, which reached as low as 26.57 in intra-day trading yesterday, is calculated from the Standard &amp; Poors 500 index option prices and measures the market&rsquo;s expectation of volatility over the next 30-day period. The fall below 30 is a combination of improved equity markets, reduced fears of a breakdown in the financial system and increased signs of a bottom in the economic data, according to Ashraf Laidi, chief market strategist at CMC Markets.<br /><br /> <!--StartFragment--><strong>JITTERY INVESTORS</strong>&nbsp;<br />In late October, the Vix hit a high of 89.53 as investors became exceedingly jittery following the collapse of Lehman and the US government&rsquo;s bailout of the insurer American International Group, which brought the fate of the whole financial sector into doubt.While 30 seems an unusually low level given the record highs seen last autumn, the level used to be a key marker of excessive fear on the Vix during the &nbsp;years before the credit crisis. Investors&rsquo; &nbsp;relief that we have finally moved below 30 suggests just how pervasive market volatility has become in the past 12 months and how immune we have become to conditions that were once considered unusual.<br /><br />Typically, the Vix moves inversely to equities because increasing volatility in the markets and jittery investors mean that there tends to be a sell off in stocks as assets are liquidated and investors seek out traditional safe havens such as the dollar and gold.<br /><br />Its move below 30 should give investors a further boost and spread betters, who are able to bet directly on the Vix with most of the major providers, can take a punt on how they expect the fear gauge to move over the next month or so. Those who think the bear market rally is simply a false dawn could bet on a rebound in the Vix as a further sell off would see a return of the jitters.<br /><br />However, Laidi warns that the inverse correlation between the Vix and equities does not always hold, and spread betters should be wary about basing trades on either equities or the Vix itself solely on the basis that this relationship holds.<br />For example, the Vix rose to only 52 when stocks tumbled to 12-year lows in the first week of March, compared to a record high of 90 in late October, when stocks were at five-year lows. Laidi says: &ldquo;This indicates that renewed selling can emerge without fear of a systemic breakdown, which can be a reflection of speculative (March) rather than panic redemptions (October-November).&rdquo;<br /><br />If we do see any further falls in global equity indices, especially after such high hopes of a recovery, we may well see a return of the wholesale panic that stalked the stock markets back in October. The Vix&rsquo;s recent lows are sure to calm investors, but they shouldn&rsquo;t get complacent. This index of fear can be as unpredictable as any other.&nbsp;