A Renewed Look at the Volatility Landscape

The VIX is simply too high considering the market's actions

   
A Renewed Look at the Volatility Landscape

With the eurozone crisis once again capturing headlines and the U.S. equities market in the midst of the biggest correction this year, now might be an appropriate time to survey the volatility landscape.

We begin with an assessment of the actual or realized movement of the S&P 500 Index ETF (NYSE:SPY). With the recent transition into correction mode and increased chatter about investor fears, one would think market volatility should be surging.

Interestingly enough, 10-day historical volatility still sits in the single digits at 9%, while 21-day historical volatility resides at a paltry 12%. Thus far, the selling has been nothing more than a subdued, low-volatility slide. Compared to the outsized corrections of 2010 and 2011, the current dip has been quite benign.

Despite the mild-mannered moves of recent days, there has been a continual pick-up in fear as measured by the CBOE Volatility Index (VIX). Since hammering out a higher low in April at 15.75, the VIX rose as much as 38% to just above 21. Though a VIX of 21 is in line with its long-run average and thus not high based on historical standards, it is high given the current market backdrop.

VIXchart 300x220 A Renewed Look at the Volatility Landscape
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For starters, 21-day historical volatility still sits at 12%, which means the VIX is sitting at almost a nine-point premium to how much the market is actually moving right now. Unless market volatility picks up considerably, implied volatility is simply too high.

Yet another indication that the VIX has risen too far in the short term is its breaching of the upper Bollinger Band. Historically, when the VIX exceeds the upper band it provides a pretty reliable signal that there is too much fear in the market and thus we’re close to at least a short-term low. Of course, the signal isn’t infallible. Sometimes full-fledged crashes occur after the VIX has breached the upper band sending it much higher.

The tricky thing about the current situation is that we really haven’t seen any type of capitulation accompanied by a sharp uptick in fear. It’s been more of a slow grind lower in the market along with a slow grind higher in the VIX. Fading the VIX would be altogether more appealing if we could get a day or two of aggressive selling with a larger spike.

Whether it materializes remains to be seen.

As of this writing, Tyler Craig held bearish positions on VIX-related products.


Article printed from InvestorPlace Media, http://investorplace.com/2012/05/a-renewed-look-at-the-volatility-landscape/.

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