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What’s been the most interesting volatility development of late? That’s easy. It’s the assumption by Mr. Market that we will see the CBOE Volatility Index (VIX) remain at this level for quite some time.
The VIX itself predicts volatility for the S&P 500 (SPX) over the next 30 days. Given the flash crash, the high skew toward puts, all the big, bad event worries, and generally elevated choppiness recently, it’s quite understandable that we’re seeing a VIX in the low 30s. It implies an average trading range of around 2% on a given day, which is about what we have seen.
But VIX futures are what are interesting here. The curve out in time is about as flat as the plains of Kansas. Pick a VIX expiration cycle and odds are the future trades in the low 30s.
I would expect a flattish curve around the low 20s. After all, that’s essentially the ultimate mean that the VIX always reverts to over time. But low 30s? That’s where we sit now, but it’s not “normal.” A 30 VIX is elevated, plain and simple.
How elevated?
Well, the inventor of the VIX himself, Robert E. Whaley, wrote a paper in November 2008, in the throes of the last VIX explosion. Among his observations was this:
“An important way of judging market anxiety is to examine the persistence with which VIX remains above certain extraordinary levels …
“We know that the chance of observing a VIX level above 34.22 is 5%. Suppose we re-examine the VIX history to count the number of consecutive days that VIX has remained above a level of 34.22. Four periods [that] last more than 20 days can be identified: October 16 through December 22, 1987 (47 days), August 28 through October 31, 2002 (46 days), September 26 through October 31, 2008 (26 days so far), and January 8 through February 8, 1988 (22 days). So, yes, we are experiencing abnormal behavior, but, no, it is not unprecedented. We just tend to forget.”
Now, the run that started on Sept. 26, 2008, went on to obliterate all VIX records on the book before finally subsiding in the spring of 2009. But we’re not on such a streak now. Yes, we’re elevated, but the VIX has dipped below 30 in this particular move.
Of course, anything can happen. Three months from now, buying options with a 31 VIX backdrop may look like a steal. It would have looked great in 2008, but that’s far more the exception than the rule. More likely than not, there’s too much 2008 nostalgia going on.
To close, I want to share a little remembered fact: The summer 2008 market was not particularly volatile. Ten-day realized volatility in the SPX actually nestled in the low 20s all summer.
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