Bernie Schaeffer Schaeffer’s Investment Research Inc.
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The following is a reprint of the market commentary from the April edition of the Option Advisor, published on March 25. Prices and the chart are as of the close on March 25. For more information or to subscribe to the Option Advisor, click here.

Michael Corleone (to Sonny Corleone, after proposing the murder of a policeman who wronged his father): "It's not personal, Sonny. It's strictly business."
(The Godfather, Paramount Pictures, 1972)

The VIX (after refusing to break below 40 on one of the sharpest rallies in market history): "It's not sentiment, Sonny. It's strictly volatility."
(CBOE Volatility Index - March 2009)

Much is made of the VIX as a "fear gauge" - a rising VIX is alleged to indicate heightened investor fear and a depressed VIX investor complacency. The fact that the VIX is a calculation of the implied volatilities of a set of S&P 500 options, and that these real world option volatilities are very much determined with reference to recent realized market volatility, is considered a footnote at best.

But take a look at the accompanying pair of charts - one shows the daily action in the VIX since early 2008, and the other the 10-day historical volatility of the S&P over that same period. Not only is the shape of the 2 charts pretty much identical, but of even greater interest is what occurred at the 2 major market bottoms in October and November 2008 and at the plunge to 10-year lows earlier this month. We all know that the VIX peak near 90 in October was not matched at the November lows when it peaked at around 80. But as I pointed out in this space last month, note that S&P historical volatility peaked in November at about 20 points below its October level. In other words, the failure by the VIX to take out its October peak in November on the lower market lows in November can be explained - not by some mysterious "fear deficit" among investors at these lower lows - but by the fact that the realized volatility of the market fell short of October's levels.

But of greatest interest of all is the action on these charts in 2009. Despite the fact that the market took out its November lows by a large margin earlier this month, the VIX peak on this pullback was at a meager 53, which was in a different zip code from its October and November peaks. But this moribund VIX peak was perfectly consistent with S&P historical volatility - which has yet to exceed 50% so far this year - and one could argue that "investor complacency" had little to do with the refusal of the VIX this year to match its 2008 peaks. In fact, not only did historical volatility react little to market weakness, it also did not decline on the historic rally off the March bottom. The bottom line is that realized market volatility has flat-lined in 2009 at the low end of its range for the past 6 months, despite all the gyrations in the market.

And this has turned on its head the maxim that declining markets are accompanied by higher volatility (and elevated investor fear), and that rising markets are characterized by a decline in volatility.

So, what does the catatonia in market volatility - albeit at elevated levels - imply (if anything) about market direction? I would first of all suggest that you forego the temptation to view the daily gyrations of the VIX as much of a sentiment indictor, though I would say that a break by the VIX below the support at 40 that has stubbornly held in recent weeks could be an indicator of capitulation by the bears that could stoke another market surge. Another level to watch is the declining 80-day moving average of the S&P - currently at about 830 - which has contained all rallies since mid-2008. A clear break above the 80-day would represent a significant change of behavior for this market and be indicative of further upside. But another failure at the 80-day would be very ominous and would argue for a retest of the March lows.

Bernie Schaeffer:
• Developed Expectational Analysis®, a proprietary, three-tiered method of options analysis combining technical and fundamental studies with the analysis of investor sentiment.
Publisher
• In 1981, Bernie launched the newsletter, Bernie Schaeffer’s Option Advisor. Serving as senior editor since inception, Bernie has led the Option Advisor to become the nation’s leading options newsletter. Features: market commentary, specific trade recommendations, and trading strategy.
• Launched SchaeffersResearch.com, in 1997. A four-time winner of Forbes “Best of the Web” award, the website has also received positive mention in Barron’s, AAII and The Wall Street Journal Guide to Online Investing - “An independent options site that is one of the best for providing primers for both novice and advanced investors.” Features tools, quotes, data, commentary, and education.
• 10 Days to Successful Options TradingSM – This multi-media home study program teaches options basics. Learn fundamental strategies with hands-on application exercises and examples.
Author
• The Option Advisor: Wealth-Building Techniques Using Equity and Index Options (1997)
• New Thinking in Technical Analysis: Trading Models from the Masters – The industry has viewed Bernie’s Expectational Analysis® methodology as a groundbreaking approach to trading. Proof of this came with the publication of this new book by Bloomberg Press. One of twelve authors, Bernie was honored to be chosen from hundreds of market analysts to explain his methodology.
• Writes a monthly options column for Bloomberg Personal Finance magazine.
• Multexinvestor.com regularly calls on Bernie to contribute to their “Analyst Corner.”
Awards and Recognition
• Three time winner of The Wall Street Journal stock picking contest.
• Ranks fifth among market timers tracked by Timer Digest for the past decade.
• Dick Davis Hall of Fame inductee for his bearish posture ahead of the 1987 crash.
• He is known for successfully maintaining a bullish market posture throughout the 1990s.
• The Market Technician’s Association (MTA) awarded Bernie “Best of the Best” in 1997 in the field of Sentiment/Psychological Analysis.
• Bernie is regularly featured on investment chats on Yahoo! Finance.
• Bernie’s views on the stock market and the economy are regularly quoted in The Wall Street Journal, The New York Times, BusinessWeek, Investor’s Business Daily, and USA Today.
• Both Barron’s and The New York Times have featured Bernie in “Question & Answer” interviews.
• Recognized as a CNBC “Market Maven.”
• Appears regularly on national financial broadcasts such as CNBC, CNN, Bloomberg Television, the Nightly Business Report, Wall Street Week with Fortune and Fox News. Also serves as a guest host on CNNfn.
• Frequently invited to speak at national investment conferences and seminars.
• Regularly sits on Options Industry Council panels around the country.
• One of 50 market strategists appearing in BusinessWeek’s 2001 market forecast.