The U.S. stock market volatility of the last two years looks set to recede in 2010, though the unpredictability of the budding economic recovery doesn't mean investors won't seek some hedging ahead on the heels of Wall Street's double-digit gains.
The Chicago Board Options Exchange Volatility Index, Wall Street's favorite yardstick to investor sentiment, is down about 43 percent from January, and is off by 72 percent from its all time high of 80.86, reached in the midst of an economic panic in November 2008.
The VIX, as it is known, is a 30-day risk forecast derived from Standard & Poor's 500 index option prices, calculated on what investors are willing to pay for the index's options. It generally rises when investors seek options to guard their portfolios against uncertainty as stocks fall sharply.
With the worst of the financial crisis receding, expectations are that markets will return to a more normal level of volatility.
"I don't see the VIX soaring like this year, largely because the risk of fear has evaporated," said Andrew Wilkinson, market analyst at Interactive Brokers Group in Greenwich, Connecticut. "The worst-case scenarios to lift the VIX again are now behind us."
Prior to the collapse of Wall Street firm Lehman Brothers that helped trigger a global economic crisis, the index hovered between 10 and 15 in 2005 and 2006, according to Thomson Reuters data. In 2007, the index fell as low as 11.2, but soared as high as 32 later in the year as the housing market began its long meltdown.
The volatility gauge sank to its lowest level in 15 months on Nov 25 to 20.05, its long-term average, and has been near the low 20s for most of December.
"The VIX will stabilize further, as it seems to have done so already," said optionMonster co-founder Jon Najarian in Chicago, Illinois. "We see readings of low 20s for most of next year."
He added that without some volatile price movements, however, investors should not expect the stellar returns they saw this year as stocks rebounded 65 percent from their March lows. The S&P 500 is now headed for a 22 percent increase on year.
"Of course, there is always a potential of a pullback after nine solid months of rally, but the severity of the pullback is fairly limited, and there is very little chance that the pullback will bring the market down to the levels we saw in March," said Randy Frederick, director of trading and derivatives at Charles Schwab in Austin, Texas.
Some analysts said there is a possibility of the index falling below 20, a level considered "comfortable" for investors, but said the dip is not likely to last as the economy still has a long way to go.
"The potential policy changes from the government, healthcare reforms, the Fed and easing of stimulus ... there are still uncertainties," said Brian Washkowiak, equity analyst at Talon Asset Management in Chicago.
"All in all, we should see an OK recovery, not a great one, and that might be a reason for higher volatility next year."
A Reuters poll on Wednesday showed about 40 equity analysts expect U.S. stocks will score a second straight year of gains in 2010 as an economic recovery brightens the profit outlook, extending the market's rebound from the depths of a punishing financial crisis.
The survey of top Wall Street dealers, brokerages and fund managers showed a median target of 1,208 for the benchmark S&P 500 at the end of 2010.
On Thursday, February VIX futures traded at 26.50 and March futures at 27.15. The S&P 500 was 1 percent lower at about 1,100 points.
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