Monday, April 4, 2011

Quiet VIX Reflects Broad Market


Slow market could send Volatility Index lower


I know the CBOE Volatility Index (CBOE: VIX) gets imbued with some magical, mystical qualities, but at the end of the day VIX simply indexes 30 day implied volatility (IV) on the S&P 500 Index Options (CBOE: SPX). That more or less gauges where “the market” expects to see volatility of the underlying, SPX/SPY, over the next month. Options trading investors don’t know of course what will actually happen, but we can look back and see recent volatility, known as historical (HV) or realized volatility (RV) over the recent past.
Here’s a comparison over the past month, 30-day IV in SPY vs. 20 day HV.
VIX Historic Volatility vs. Implied Volatility

And it sure looks like options prices are in line. But alas, all is not as it appears. The 20-day HV still includes that March volatility pop. But as luck would have it, that last wild day, March 16th, has now left the 10 Day HV calculation.
Here’s how 10-day HV looks over the past month.
VIX 10-Day Historic Volatility
As you can see, the first graph very much misleads. HV has had an awful two weeks. You obviously have felt that in actual trading, it just didn’t quite reflect yet in the numbers.
You need not wait for time to catch up to price though, you can always guestimate realized volatility on a day-to-day basis. Remember the Rule of 16? Simply take the percent range of SPX/SPY in a given day and multiply it by 16 (its roughly the square root of 252, the number of trading days per year). That converts it to a volatility number. For example, if SPX/SPY moves about .5%, multiply it by 16 and you get an 8 volatility. If you see that more or less happen every day, that’s the actual volatility in the market.
And that’s exactly what we’ve seen for the past two weeks.
So while VIX seems cheap around 18, what with all the international news floating around, it iss actually high when you consider the snail pace the market is moving now. No, I don’t believe VIX or volatility in general is a sale right now, but I would note that we need a pick up in the action pretty soon to justify even these prices.

No comments: