Parsing every little tweak in the VIX sometimes causes me to lose sight of the bigger picture. So let’s take a step back. The VIX has found a pretty comfortable range here. For about five weeks now, it has pretty much stopped at 22 on the upside and found support at 18 on the downside.
By historical standards, that’s a pretty reasonable level to churn through. The VIX has a long-term mean very near 20, so in that sense, we could see a level closer to fair.
This, however, belies some real changes under the surface. The market itself has strengthened quite a bit since then, even factoring in the weak stretch last week.
Here is a chart of the SPDR S&P 500 (NYSE: SPY):
With SPY up between 4% and 5% in a little over a month, the VIX hasn’t budged. Hmm. Maybe realized volatility has ticked up? Or not.
Here’s the 10-day historical volatility in SPY over the past two months:
It ticked up a bit lately, but has actually drifted since early October. So it remains more apprehension about future volatility than reaction to current volatility that’s keeping VIX nestled around here.
Volatility expectations have abated, however, if you look at VIX futures and VIX futures ETNs like the iPath S&P 500 VIX Mid-Term Futures ETN (NYSE: VXZ):
VXZ proxies four-to-seven-month VIX futures. From top to bottom, VXZ dropped 20% during a period of churning VIX.
So, what’s it all mean?
I believe it suggests VIX itself will have trouble pushing much higher from here. The VIX overprices realized volatility in the market, and it “over-fears” a decline in the market itself.
Trading VIX products may not prove disastrous, though. VIX futures still carry premiums across the curve, but not at an enormous magnitude. The four-to-seven-month futures in VXZ trade about $5-$6 over VIX. This ETN has a history of only about 22 months, so there’s not a lot to go on, but that’s not a high premium with the VIX itself at a middling level.
If you hold a VIX future of that duration, it will eventually move to parity, but if you hold VXZ, it will not. There is the risk that the VIX itself will decline, but the futures premium part of it should hang relatively steady.
Follow Adam Warner on Twitter @agwarner.
