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The Indomitable Investor: Why a Few Succeed in the Stock Market When Everyone Else Fails by Steven M. Sears

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Apathy and Fear Are Your Friend

Investors regularly use the SKEW Index and VIX with great impact. Consider the 2011 nuclear disaster at Japan’s Fukushima power plant as an example of how investors use volatility’s ebbs and flows to better navigate the stock market’s inevitable rise and fall. In the week before the nuclear reactor meltdown, implied volatility as measured by the CBOE’s VIX was declining as the stock market sharply advanced. This is a normal event. The VIX and stock prices are supposed to move in opposite directions. Prior to the meltdown, the VIX hovered below 20, and as low as around 15. Many investors thought VIX was too low, and more arcane measures of volatility were even lower. They felt volatility was ignoring the problems in the U.S. economy and the risk of owning stocks, suggesting nary a concern that some unknown event, some black swan, would derail the stock market. In the midst of this, many traders and investors bought index puts. The positions were adjusted and readjusted as volatility ebbed lower and lower. These traders effectively black swanned their stock portfolios simply because the fast rise in stock prices had dramatically lowered the price of bearish puts on the Standard & Poor’s 500 Index. Prior to the meltdown, the VIX hovered around 15. When the tsunami hit, the VIX quickly doubled. Those investors who had bought index puts, of course, never imagined an earthquake would cause a tsunami that would damage a nuclear reactor that would raise ...

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