By and large, the VIX has sat in a range lately. But that didn’t stop us from a (very brief) moment of excitement the other day as our fine volatility tracking friend busted above the 20,2 Bollinger band.
Always remember that the VIX is a mean-reverting instrument. It can trend, of course, but for the most part, you want to look for extensions from some sort of mean, and then fade in to some respect. This time that theory worked perfectly in hindsight. One little blip above and … wham, overbought … and the VIX quickly declined. It doesn’t always work that way, though, so don’t feel like you missed it.
Going forward, the VIX faces some headwinds. We have a big holiday week coming up, which means lots of football and turkey, and relatively little trading.
The VIX proxies a hypothetical at-the-money (ATM) S&P 500 (SPX) option with a 30-day duration. As of tomorrow, the next 30 days start with a normal weekend, a slow trade for three days, a holiday, a half session that generally produces nothing, and then another weekend. That’s 10 days of which we expect light volatility in the SPX itself.
If you bought an SPX option with 30 days duration, you would not want to pay full fare knowing that the first third of the life of that option will be sleepier than a turkey coma. Ergo, you lower your bids. Sellers willingly lower their offers as well, all of which has the effect of lowering the implied volatility of the options. And if implied volatility declines, so does the VIX (by definition).
And it doesn’t end there. We have another big holiday week at the end of year. Once Thanksgiving goes, we’ll have Christmas and New Years on the back end of the VIX calculation. And again, no one’s paying up for options when you don’t expect to see stocks fluctuate.
None of this makes options a bad buy, per se. If time gets cheap, it’s a buy, just like any other month of the year. Just make sure cheap is actually “cheap” and not simply “lower than we just saw it.”
Follow Adam Warner on Twitter @agwarner.