VIX – VXO Spread: Risk appetite & diversification (uptd)

Today’s chart looks at SPX Index since January 1995 overlaid with spread between VIX and VXO. VXO is implied volatility index for S&P 100 index and VIX is for S&P 500; S&P 100 is index of 100 companies and S&P 500 is of 500. Hence VIX will trade at lower levels than VXO as the former has higher degree of diversification than the latter. And investors’ preference for diversification depends on investors’ risk appetite - during episodes of high risk averseness investors prefer diversification hence prefer S&P 500 over S&P 100 there by the spread narrows and we see that during the bout of high risk averseness the spread plunges into negative zone. When risk appetite increases the spread increases and trade above zero as seen during 2005-07. Over the last five trading sessions VIX exceeded VXO which shows that risk appetite of the investors are on rise which is good for the market. Another take from the chart is that despite current crisis being termed as one of the worst recessions since the Depression the retracement of risk aversion has been narrower compared to the ‘V’ of Tech bubble crisis.