Australia 200 - Complacency

Australia 200 - Complacency

The Australia 200 index has hit another 5 year high at 5,320. A daily and weekly close at these levels could be interpreted as a bullish signal, and may spur technical buying come Monday. However, I'm still comfortable staying short the index - and here's why:

Australia 200 volatility index

20130927 as51vix

The VIX is compiled by the ASX from the index options market. It's a measure of "implied volatility" - the estimate of future price changes that professional option traders feed into their pricing models. These estimates also reflect supply and demand factors.

Options can be compared to insurance contracts - investors can use them to insure against market risks. As the chart shows, current demand for portfolio insurance is near 2013 lows. This puts the VIX closer to "complacency" than "fear". This aspect of investor sentiment has clear implications for the index:

Australia 200 index

20130927 xjo

There is an inverse correlation here. Naturally, as markets fall, fear increases. As markets rise, increased confidence can turn to complacency - setting the market up for a potential fall. While volatility is not a perfect predictor of market conditions or direction, the low levels of volatility at the present suggest to me that the market is unprepared for a fall, potentially magnifying any momentum on the downside.