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Well, at long last, it's here! The Chick-fil-A FedEx FedMaGeddon Taper Throwdown Year-End Spectacular presented by Vizio!
It's quite simply the Biggest Fed Decision Ever. At least until it happens, at which point we watch the market reaction and then say, "that was exciting, but I'm really apprehensive about the next Fed meeting." And so on.
But hey, that's all for another day … probably later this week. We're talking here and now, so let's check out the volatility landscape.
The CBOE Volatility Index (INDEXCBOE:VIX) sits near 16, which is its high-water mark since mid-October. A 16 VIX conveniently implies an underlying market that moves greater than 1% on roughly one of every three sessions. Or rather, it anticipates a market that will see that sort of volatility over the next 30 days. Or rather, rather, it anticipates a large gap, like an earnings move.
I'll go with the "rather, rather." We now have a couple of months of "live" data on the CBOE S&P 500 Short-Term Volatility Index (VXST), the new shorter-term VIX. And suffice to say, when the VXST is higher than the VIX, the market anticipates volatility sooner rather than later.
Here's the VXST versus the VIX: (Click on the charts below to enlarge.)
The ratio has been above 1.0 for the last week, but it's not as high as we saw back in October. Then again, the VIX itself peaked over 21 in October, so it makes sense that the ratio is lower now. Volatility is more … volatile (sorry) … the nearer an option sits to expiration. The more time an option has until expiration, the more it treats near-term market moves as "noise," and assumes volatility will mean-revert.
Right now, it's a low-octane version of the volatility picture in a stock just ahead of earnings. The nearest-term option gets the biggest lift in volatility terms ahead of the anticipated gap in the stock. The news comes out, the stock presumably gaps a bit, and implied volatility gets slammed. The real question is whether the gap in the stock is big enough to offset the drop in implied volatility going forward. If the gap is big enough, then the net owners of options "win" on the trade. If it's not big enough, then the net-options sellers "win."
We really won't know which side of the options trade is better until after the fact. We can make a high-probability guess, though, that the VXST will get slammed, and the VIX will likely drop, too, after the news.
So, we should just "sell" the VIX, right?
Well, it's not that simple. Here's the VIX term structure as of yesterday morning (chart courtesy of VIX Central).
Mr. Market already knows that the VIX itself is likely to dip after the Fed. Both December and January futures trade at a discount to the VIX itself. So yes, you can sell them, but you're not selling the VIX at the price you see on the board.
You can net sell actual S&P 500 Index (SPX) options, but then you're really just betting on the immediate Fed reaction, as we noted earlier. Does your win on the volatility dip offset your potential loss on the move in the actual market?
All things considered, the anticipation in the options market doesn't quite match the anticipation in the media. The 10-day realized volatility has ticked up a smidge recently to near 10. So the VIX itself has maybe a 2-3 point premium over where we'd see it right now in the absence of expected news.
My trading platform shows that the SPDR S&P 500 ETF Trust (SPY) anticipates about a 1.5% move on "the number," which sounds about right.
Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.