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May 9, 2008

Thrills and Chills

Traders adjust to historic levels of volatility

By James Ramage

As trading environments go, the current one almost couldn't get any wilder. Experts say today's equities market hasn't been this volatile since the Great Depression. The large jumps in prices have meant greater risk, higher volumes and wider spreads for traders intermittently for more than seven months.

But the buyside hasn't crumbled in despair. And their latest electronic tools haven't led them off a cliff, as some expected. Instead, traders have tackled the volatility and adapted. Many have made some key changes to their trading strategies and found ways to lower costs and find opportunities.

On its face, the volatility presented great challenges to traders. And it appears many have met them.


"Regardless of whether you're on the buyside or the sellside, volatility certainly poses challenges," says Jason Lenzo, head of trading for equities and fixed income at Tacoma, Wash.-based Russell Investments. "The biggest challenge that faces anyone, regardless of where they sit in the whole financial cycle, is that you have to alter the way you look at the world because market norms have changed dramatically."

Those market norms began to change around August 16, 2007.

On that date, the Dow Jones Industrial Average careened more than 540 points between its high and low for the day before it settled on a modest drop at the close. A new round of volatility had arrived. And judging by the market conditions that produced it, it was going to stay for a while.

Fasten Your Seat Belts

More important than the gyrations themselves, fear about subprime-mortgage-backed securities and emerging credit troubles was growing in the hearts and minds of many. That fear created a powerful whirlwind of uncertainty which tore into the equities market.

And though the volatility's intensity has risen and fallen in successive waves since then, it's still here. In fact, it's here to such a degree that according to one industry study, 2008 is shaping up as the most volatile year in seven decades.

Some major gauges paint a particularly impressive picture. According to a Standard & Poor's study, the market-year-to-date through much of March is as volatile as it's been since 1938.

The ratings firm measures S&P 500 volatility by daily changes in the index of at least 1 percent, either up or down (see page 38). This year the number of major daily market moves stands at a staggering 51.9 percent-the highest since 1938, when 57 percent of the days saw significant index moves.

By comparison, the number of significant daily index changes for 2006 was 11.6 percent. And the figure was 12.9 percent for the first six months of 2007, or just before the volatility struck.

For context, the S&P 500 on March 7, 2003, started its steady, yet jagged, climb to a four-year high point when the subprime implosion began. It moved from 828.89 that day to 1,553.08 on July, 2007.

The Chicago Board Options Exchange's Volatility Index, or VIX, had mostly been holding in the low to mid-teens since early 2004. But since mid-August, when it jumped to 30, the VIX has registered at least 25 periodically ever since-including early September, much of November, half of January, most of February and all but one day in March.

Whence Comes Volatility