Stock market volatility has not just been low of late. In the wake of the Brexit “V bottom,” the CBOE VIX index has been touching abnormally low rates by historical standards. With all the risk in the world, what is the problem?
Stock Market Volatility at historic lows
The report pointed out the S&P 500 has not moved over +/-1% on a close-to-close basis for 43 straight trading sessions – a relative historical anomaly. On average the SPX has been up 0.26% each day over that period, translating in a rolling realized volatility of 5.3 over the past two months. With all the potential volatility producing events circling the market – a potential US rate rise, political concerns not just in the US but also Europe, and a growing war with a generally invisible terrorist enemy that has control of wide swaths of the oil rich Middle East — the nearby rolling VIX average is at its lowest level since 1968.
Gregory cites as the catalyst being “clear” — S&P 500 one-month trailing realized vol has dropped to 4.8. Going deeper, he asserts the VIX is designed to be a forward looking indicator, but in fact it shows a trailing correlation to the previous month’s volatility of 88%.
“…Absent an impending catalyst, traders often look in the rear view mirror when pricing options,” Gregory noted, pointing to the circular role volatility plays in options pricing and vice versa. “All else equal, low realized volatility environments tend to cause low VIX levels.”
There has been a vigorous debate about the predictive accuracy of the VIX. Some analysts have pointed to the correlation between VIX and related markets as a more important indicator than the measure by itself.
Regardless of the predictive use of the VIX, one thing is clear: hedging and long VIX exposure has been difficult to stomach as of late.
Stock Market Volatility – It has been historically difficult to get much of anything from long volatility trades
Investors often buy options to hedge their stock portfolios, Gregory notes, and lately such purchases have been nothing short of a wasting asset. “This short 1m VIX futures index is up 102% since June 27,” he wrote. “That puts perspective on how tough it has been to hedge in the face of a falling VIX.”
Contrast that with Long 1 month and 6 month VIX futures strategies being down -18% to -54% since Brexit, and the market environment for volatility is tough.
Volatility is extremely low, but with an increasingly uncertain election approaching, being on the right side of volatility and properly managing hedges could be the difference between success and failure.