The VIX has broken down below 20 again, back to pre-flash-crash levels, but does that mean options volatility has gotten cheap?
By a pretty objective definition, the relationship between options volatility and realized or historical volatility says options are actually not cheap right now.
Here is the 10-day realized volatility in the SPDR S&P 500 (NYSE: SPY) over the past three months:
This measures volatility of SPY itself over the past 10 trading days, and as you can see, it has sat between 10 and 12 for the past two weeks. That’s a really noisy number (it was twice as high as recently as early September, for example), but it gives a good read on the current market pulse. After all, options price based on the “feel” of the volatility backdrop. And right now, it feels tight-ranged and bullish.
If you prefer a little more data in your realized volatility, here’s the 20-day historical volatility in blue alongside 30-day implied volatility of SPY.
That 30-day IV number is similar to the VIX, but always “prints” modestly lower, as it does not include all of the out-of-the-money (OTM) puts that the VIX often does. But as you can see, there’s a rather large disparity between options prices and realized volatility. And, yes, it’s because options price too high right now.
That’s unsustainable, of course. If you pay 17 volatility for options on SPY, and it moves consistently at an 11 volatility pace, you will almost certainly lose some money each day.
But, alas, this is not an apples to apples comparison. Historical volatility looks backward, 10 trading days in the top graph and 20 in the lower graph. Implied volatility predicts forward, 30 calendar days for the yellow line in the graph here, and 30 days for the VIX as well. So perhaps realized volatility will perk up soon and paying 17 volatility for SPY options will prove correct. Or perhaps not. And if it doesn’t, the VIX will get cheaper still as options buyers grow tired of overpaying for protection.
Until this resolves one way or another, disregard anyone that calls VIX cheap. Right here, right now it is anything but.
Follow Adam Warner on Twitter @agwarner.