If you’re looking for information on Canadian options and insight into Canadian market volatility, you need to look no further than the Montreal Exchange’s MX implied volatility index.

The MX implied volatility index (symbol: MVX) measures the level of option premiums on S&P TSX 60 iShares (symbol: XIU). The idea is to provide investors with an idea of how volatile participants believe the stock market will perform over the next month.

You can find an intraday chart of the MVX on the Montreal Exchange’s home page (www.m-x.ca/accueil_en.php) . Click on the MVX link under Index Description to go to a year-to-date chart of the MVX overlaid on a year-to-date chart of the XIU.

In the accompanying chart, you can see that the MVX has been declining since it peaked at 24% in early June, when the XIU bottomed. At the time of writing, the reading was 18.04%, well below this year’s peak but considerably above the 2006 low of 11.8% in March.

“MVX is calculated from current prices of nearly at-the-money options on the TSX 60 iShares. MVX is an implied volatility index updated every minute of a trading day,” says the Montreal Exchange’s Web site. “Since the value of XIU is derived from the S&P/TSX 60 index — the equity benchmark in Canada — MVX is a good proxy of investor sentiment for the Canadian equity market. The higher the index, the higher the risk of market turmoil.

“A rising index, therefore, reflects the heightened fears of investors in the coming month,” it adds. “MVX also gives an indication of whether options are relatively cheap or expensive, as the higher the implied volatility, the higher options premiums become. ‘Implied volatility’ represents the volatility built into the price of an option in the market. Implied volatility is particularly important because it determines market consensus about the probable volatility of the underlying stock in the future. Implied volatility reflects market supply and demand for the price of an option.”

The MVX measures the volatility being implied by the near-month at-the-money index calls and puts. Usually, these options are the most actively traded options and, by extension, tend to look and act most like an average options contract.

Some technicians use the MVX to gauge the mood of Canadian investors in the same way as U.S. investors use the Chicago Board Options Exchange’s volatility index (symbol: VIX) to measure investor sentiment south of the border.

In the U.S., volatility indices have a 20-year history and, during that time, they have spiked at major market bottoms. Because of the negative correlation between volatility and stock market performance (volatility rises when markets are falling), implied volatility is a useful indicator of investor sentiment.

One might even argue that it’s a measure of fear and greed. The VIX peaks when the market is bottoming because its peak represents the point at which the last investor pays the highest price to purchase a put option to protect the value of his or her investments. Fear and greed are hard emotions to overcome in the marketplace, making volatility particularly insightful.

As the MVX matures, I expect we will be able to draw similar conclusions from the Canadian market. But first we need to understand where average premium levels should be. So far, the three-year average volatility reading has been somewhere between 15% and 16%.

Until recently, the Canadian market did not experience the kind of volatility that is the norm in the U.S. (The MVX typically trades at lower volatility levels than the VIX.)

This has a lot to do with the makeup of the S&P/TSX 60 index, which has a heavier weighting in natural resources companies. Particularly important is the weighting in oil and precious metals, which move counter to the general market. Within the context of a portfolio index, heavier weightings in counter-cyclical industry groups tend to smooth out the fluctuations in the overall index. But over the past few years, oil and gold have been the major influences on the world markets, and they have pushed up the numbers on the MVX. IE