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VIX Concepts often Miss the Volatility Boat

Well, we like to sometimes (often) pick on CBOE Volatility Index (VIX) tweets. Yesterday we had this.

“First time in a year that the market has been making new highs and the VIX has not made new lows.”

I bring this one up because it infers several commonly held VIX misconceptions in one neat 140 character package. Options trading can lead to misconceptions.

First of all, VIX is but one measure of volatility. Here’s a similar, but modestly different one from Ivolatility.com. The yellow line shows 30 day implied volatility (IV) of the SPDR S&P 500 (NYSE: SPY) using their proprietary model.

CBOE Volatility Index

Blue=Historic; Yellow=IV Index

So no, it hasn’t quite hit new lows. But it’s pretty darn close. And given that each session contains so many variables like day of the week, day within the expiration cycle, et. al., it’s a statistically insignificant difference.

But let’s play devils advocate and take it a step further and ask why SPY IV (and VIX) sit higher despite a higher SPY/SPX ( the S&P 500 Index options).

Yes, VIX moves in opposition to the market, but not perfectly so. In fact it has a roughly -.66 correlation. Remember VIX measures volatility. And sometimes volatility actually picks up during market rallies, and declines during market drifts. Here’s 10-day realized volatility in SPY over the past three months.

Volatility Chart

10-Day Historic Volatility

Quite simply, realized (AKA historic) volatility has seen a notable pickup lately. If you compare this to the 30-day IV in the first graph, you would actually make the opposite conclusion as the highlighted tweet. Namely, that implied volatility now is actually as cheap as its been at any time in the last month, provided you relate it to realized volatility in the market.

Of course this comparison has flaws too. Realized volatility looks backwards, whereas implied volatility guesses forward. The best way to look at this picture is that options pre-anticipated a pickup in realized volatility for a month before the Egypt crisis actually delivered the pop. And most interestingly, that pop really didn’t change the overall volatility picture much, save for last Friday’s very brief blip. VIX futures barely moved. Neither did longer-dated options (in volatility terms).

Going forward, it sure looks like that little spike in realized volatility will prove a one-day wonder. And once that “blue line” dips again, we get right back to where we were. Implied volatility is cheap versus itself, but a little high versus realized volatility. In other words, normal.

Follow Adam Warner on Twitter @agwarner.


Article printed from InvestorPlace Media, https://investorplace.com/2011/02/vix-concepts-often-miss-the-volatility-boat/.

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