Can u predict panic/exuberant situations in Stock Markets ?

Last week was an unprecedented week in the Global stock markets where every market open very very weak and looks like there was gloom and doom after the news of Lehman Brothers filing for bankruptcy and Merill Lynch being taken over by the Bank of America. Added to this, there was a possibility of AIG going down under till the US federal government bailed it out by infusing $80 Billion for an 80% stake in the company.

However towards the end of the week many of the central banks infused large sums of money into the money market system to keep the systems up and running and preventing any kind of a global melt down.

While markets recovered, would it have been possible for to one to predict the amazing turnaround prior to the actual event of turnaround ?

My answer is 'Yes'. It is possible if one were observing the the Market Volatility Index (VIX). In the US is a measure of implied volatility in trading of S&P 500 futures on The Chicago Board Options Exchange. The index is calculated using a formula that considers a large number of option strike prices, supposedly in a way based on current financial research and practice. Values for VIX tend to be between 5 and 100.

The VIX is said to to measure market sentiment (or, more interestingly, to indicate the level of anxiety or complacency of the market). It does this by measuring how much people are willing to pay to buy options, typically 'put' options which are a bet that the market will decline. When everything is wonderful in the world, nobody wants to buy put insurance, so VIX has a low value. But when it looks like the sky is falling, everybody wants insurance in spades and VIX heads for the moon. Practically, even in the most idyllic of times, VIX may not get below 12 or 13. And even in the worst of panics, in 1998, VIX did not break much above 60.

Many view the VIX as a contrarian indicator. High VIX values such as 40 (reached when the stock market is way down) can represent irrational fear and can indicate that the market may be getting ready to turn back up. Low VIX values such as 14 (reached when the market is way up) can represent complacency or 'irrational exuberance' and can indicate the the market is at risk of topping out and due for a fair amount of profit taking. There's no guarantee on any of this and VIX is not necessarily by itself a leading indicator of market action, but is certainly an interesting indicator to help you get a sense of where the market is.

The current VIX number from Yahoo Finance
http://finance.yahoo.com/q?s=^VIX&d=1d


The reading of VIX reached almost 45 in 1998 as the LTCM (Long-term Capital Management) crisis exploded. It took a few months for the investor’s fears to abate and the VIX to return to below 20. The World Trade Centre bombing also made the VIX climb above 45, as the investors’ fear level reached the zenith. Similarly last week the value of VIX went as high as 42 thus signalling turnaround which happend in a couple of days.

India VIX
India VIX is a volatility index based on the Nifty 50 Index Option prices. From the best bid/ask prices of Nifty 50 options contracts (which are traded on the F&O segment of the NSE), a volatility figure per centage is calculated, which indicates the expected market volatility over the next 30 calendar days.

Higher the implied volatility, higher the India VIX value and vice versa. The India VIX value has been made available from April 2008 and one can check the value of the India VIX.