With the market down six days in a row, one might think fear would be permeating Wall Street. But, curious enough, fear — at least as measured by the CBOE Volatility Index (VIX) — has been notably absent during the recent selling bonanza.
While the S&P 500 index is down 2.8% since last Thursday’s open, the VIX is up only 4% — a pittance compared to its performance during other comparable market slides.
Worse yet, the iPath S&P 500 VIX Short-Term Futures ETN (NYSE:VXX) is up a mere 1%, no doubt disappointing any short-term traders who snatched up shares last week in hopes of cashing in on the recent market weakness.
So, believe what you will about the current six-day losing streak, but it certainly isn’t causing a mad dash into the options mart in search of protection.
Of course, the apparent lack of concern can be interpreted a few different ways. From a bullish perspective, we might make the case that the volatility markets are acting as a leading indicator. The unwillingness of option players to bid up implied volatility may be signaling the sell-off is either close to termination or will continue to be a fairly benign.
On the other hand, cynics might say option traders are asleep at the switch and are in for a rude awakening if the sell-off persists. Such a sour turn of events may eventually lead to a rapid lift in the VIX as traders come to terms with a more volatile reality.
Perhaps the strongest argument for the sleepy VIX can be made by putting recent market movements in proper context. Interestingly, actual market volatility as measured by 21-day historical volatility has been falling during this six-day slide, not rising.
While the correction may be characterized as persistent, it may not be characterized as all that volatile. Over the past week, 21-day historical volatility has fallen from 18% to 16%. Since June 29, it’s actually dropped from 20% to 16%. I suspect this explains in large part the unwillingness of option traders to bid option prices any higher.
Click to EnlargeVXX’s poor performance has been further exacerbated by the term structure of VIX futures remaining firmly entrenched in contango territory. If VXX is unable to get off the floor during a market sell-off, you can imagine how it will behave when the bulls return to lift the market from current levels.
Bearish plays continue to look appealing on VXX. Traders might consider purchasing August puts or put spreads such as the Aug 14-12 bear put spread (buy the Aug 14 put, sell the Aug 12 put).
At the time of this writing Tyler Craig had no positions on VIX or VXX.