Stocks quoted in this article:
So how volatile was the market in 2013? Not so much. Steve Russolillo had some interesting stats here in yesterday's Wall Street Journal Morning MoneyBeat:
There have only been 24 days this year in which the [Dow Jones Industrial Average] closed up or down by at least 1%, matching the lowest amount for a calendar year since 2006, according to Daniel Wiener, chief executive at Adviser Investments in Newton, Mass.
By comparison, there were 89 such days in 2011, as stocks whipped around amid the European debt crisis and the downgrade of the U.S. credit rating. There were 109 such trading days in 2009, when stocks bounced off the bottom, and 134 days during the depths of the financial crisis in 2008.
A look further out on the volatility spectrum shows a similar story. There have only been three days this year in which the Dow finished up or down by more than 2%, according to Mr. Wiener's calculations. That is also the fewest number of days since 2006. There were 32 such days in 2011, 45 in 2009 and 72 in 2008.
And there's also this factoid from Bespoke:
The S&P 500's maximum decline from a peak this year using closing prices (-5.76%) is the smallest since 1995 (-2.53%).
That stat from 1995 is unbelievable … but the lack of major pain in 2013 is pretty impressive as well.
This is all part of why it's tough to make the case that the CBOE Volatility Index (INDEXCBOE:VIX) is cheap right now. Consider the experience of a dedicated options seller in 2013. Let's say his strategy is to sell straddles and strangles in indexes or ETFs that track indexes. As the market lifts, he will buy futures or the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) to keep his position delta neutral, and as it drops, he'll sell futures and SPYs. He will make money basically if he loses less on hedging than he makes on his premium decay. Or, if the market moves in one direction, he'll make money if his hedge side "wins" to offset his straddle and strangle losses.
So how did a guy like this do in 2013? I'm guessing quite well. The worst case is that he gets violent swings and gets whipsawed again and again defending his positions. The best case is a slow-moving market. Even if it only goes one way, he'll have plenty of time to buy enough futures and SPYs to offset any options losses.
And if selling options premiums is generally working, why not keep doing it? Conversely, the guy on the other side of the trade, the long volatility player, probably had a tough year in 2013. He did fine if he let his longs ride, but that's easier said than done.
The marketplace has a pretty clear reaction. Volatility buyers will want cheaper and cheaper prices, and ergo the VIX drops.
The best proxy for this is the relationship between backwards-looking historical volatility and implied volatility looked at in the rearview mirror. And pretty clearly, the market spent 2013 overpaying for the volatility that was ultimately realized.
The cycle will reverse someday. Options sellers will start getting whipsawed and burned and will start demanding higher prices, and VIX will rise and VIX futures will explode and … well, VIX futures already anticipate this cycle change, we went over that yesterday.
What about history repeating itself? We have the fewest big moves in the Dow since 2006. Volatility started trending up in 2007, so clearly we'll see that pattern repeat in 2014, right?
Who knows. It will happen someday, but just be careful relying on sample sizes of one. And it's really one of two, when you consider that the market did quite well for five more years after the extreme complacency of 1995.
Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.