Wall St 'fear' index drops to six-year low

By Ryan Vlastelica

NEW YORK (Reuters) - The VIX, Wall Street's favorite measure of investor anxiety, fell on Monday to levels not seen since April 2007, extending a decline that suggests markets will stay calm.

The CBOE Volatility Index <.VIX> dropped 7.2 percent to 11.69, reaching a level not seen since April 2007 as U.S. stocks have extended gains, putting the broader S&P 500 less than 1 percent from an all-time closing record high.

Some of Monday's move relates to the monthly change in the contracts used to calculate the VIX, so the decline should be read with a bit of caution.

The drop was notable as it came on a day when the S&P 500 has been little changed, lately up 0.2 percent. Typically, the VIX has an inverse correlation to equities, falling at a similar rate to a rise in broader indexes.

The VIX Index, a 30-day risk forecast of market volatility, is calculated using the midpoints of the bid/ask spread from a strip of near-term S&P 500 index options.

"It's very unusual since it is dropping at the same rate that it has on days when the S&P is up three or four points," said Donald Selkin, chief market strategist at National Securities in New York. "That indicates a certain amount of investor complacency, and the lower it goes, the more it seems like there is an upside cap on the market."

Equities have been on a tear so far this year. The Dow hit another record intraday high on Monday and has gained 10.2 percent so far in 2013. The gains have come on strong corporate earnings. The stock market's advance over the years has been driven by accommodative monetary policy from the Federal Reserve, despite concerns over U.S. government gridlock and overseas economic weakness.

Some of the day's decline can be explained by "a quirk that happens every month in its calculation," said Bill Luby, publisher of the VIX and More blog in San Francisco.

As the market approaches the coming expiration of March SPX options on Friday, the calculation of the VIX changes. As of Monday, the VIX is now calculated using prices of April and May SPX options contracts, instead of March and April contracts used last week, according to the CBOE.

As stocks have rallied, futures activity shows traders have been building a net short position in VIX futures over the last several months. That means they expect the VIX to continue to decline. According to Friday's data from the Commodity Futures Trading Commission, speculators have a net short position of about 80,000 contracts, less than the high of 110,000 reached in early December.

"The move in the VIX could suggest investors anticipate further gains, but the level of 10 is a cap. If it gets that low, we'll very likely have a correction," said Selkin, who helps oversee $3 billion in assets.

Action in VIX-related securities was also active. The iPath S&P 500 VIX Short-Term Futures ETN , which tracks short-term futures contracts on the VIX, was down 3.9 percent at $20.78. It has tumbled more than 33 percent so far this year.

The exchange-traded note has about $1.08 billion in assets, according to Lipper data, down from $2.10 billion at the end of August 2012. At the same time, volume has accelerated, with the average trading volume swelling from 7.8 million over the past 50 days to 11.1 million over the past 10. (Additional reporting by Doris Frankel; Editing by David Gaffen and Jan Paschal)