Every time we have some perception that the market has underpriced risk, we get an article positing that the VIX has lost its relevance. As if on cue, we get this from International Financing Review.
“Doubts have been raised over the value of the CBOE Volatility Index (CBOE: VIX) – better known as the VIX – as Wall Street’s famed fear gauge, with some market participants expressing concern that the proliferation of VIX-based products is reducing the likelihood of the instrument spiking.”
We’re worried that listing volatility products constrains volatility? Doesn’t the world in general actually want reduced volatility? If we could stabilize everything by simply listing volatility derivatives, then let’s just keep listing them!
Unfortunately, its not that simple. And in all fairness, the header of this article, the teaser up front, and that first paragraph I just cut and pasted bely the fact that the article itself simply presents two conflicting viewpoints. One, that volatility derivatives serve to effectively sit on the VIX and makes it less useful as a sentiment gauge. The other viewpoint disagrees, as expressed by Stephane Mattatia, global head of equity flow engineering at Societe Generale in Paris.
“Volumes on VIX long-only strategies today aren’t very different to a year ago, which did not prevent the VIX spiking during the sovereign crisis and the Flash Crash. Also, it would mean that positions on VIX futures do not only impact the VIX itself but also all the huge and liquid options markets on the S&P 500, which I doubt is feasible. Finally, we have not seen any dislocation between the VIX and VIX futures, which you would expect to see if increased volumes were having an impact.”
I totally concur. If nothing else, if you believe the iPath S&P 500 VIX Short-Term Futures (NYSE: VXX) is moving the VIX around, then you truly believe in the tail wagging the dog. Dollars invested, positioned, and traded in the S&P 500 Index Options (CBOE: SPX), SPX offshoots, and options on all the above dwarf the dollars in the entire VIX complex. Plus there’s no locked-in arbitration trade. VIX futures can (and do) maintain varying premiums to VIX itself. They only converge at the moment the VIX futures settle.
I do believe increased hedging in general serves to contain VIX. 2008 is still not all that far in the rearview. There’s clearly more desire to stay hedged in case of catastrophe. And the more protection everyone owns, be it from puts or Inverse ETF’s or VIX derivatives, the less likely that catastrophe actually happens. But VIX products themselves haven’t caused this action by their mere existence. They’re just one of the many instruments used for this purpose.
Follow Adam Warner on Twitter @agwarner.