Schaeffer's Outside the Box Blog

Merry VIX-mas

by 12/24/2012 7:32 AM
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As we loom our way to the fiscal cliff, we have some modestly interesting action in the volatility space.

The CBOE Market Volatility Index (VIX - 17.84) normally behaves quite poorly in the year-end stretch. Unless, of course, we have news pending, and it looks like we'll have that through the end of December (at least).

And even though the VIX does not look high in absolute terms, it's pretty strong in every other respect. The 10-day moving average is at about 16.70, so the close Friday is about 12% above this trendline. I personally view the VIX through a mean reversion lens, so a 10% deviation from the 10-day gets me interested, and a 20% deviation gets me looking to fade the move in some fashion. I have my eye on the VelocityShares Daily Inverse VIX Short Term ETN (XIV - 17.21), the inverse of the iPath S&P 500 VIX Short-Term Futures ETN (VXX - 32.54). We did get within spitting distance of the trigger -- about 20 in VIX -- but it gave up a bit too soon.

The VIX also acts well relative to realized volatility (RV). The 10-Day RV hit a low of 5 at the beginning of the week, but "rallied" to 12 by Friday. The VIX typically carries about a four-point premium to RV, so even with market volatility springing to life, it's still modestly overpriced at about a six-point premium. I always do like to emphasize that RV looks backwards and implied volatility (the VIX, in this case) prices forwards, so we always need to view this relationship subjectively.

Perhaps the most informative development has taken place in the VIX futures marts. January VIX trades near parity to VIX itself, while February carries only about a 0.5 premium to January. This is as flat a near-month term structure as we've seen in just about forever. It is consistent with the notion that the VIX itself carries a modest "news" premium. Once the fiscal cliff un-looms, the curve will likely resume its normally scheduled up-slope.

As long as it stays flat, though, it has an impact on our old friend VXX. It won't get hammered by the standard near-month contango, as it faces a reduced cost of rolling. Of course "reduced" does not equal "zero" just yet; there's still a 0.5 premium from January to February, down from readings of 2 and above this year. Not to mention that the VIX itself is modestly elevated (as we just noted).

The VIX curve has flattened out in time as well. June VIX carries about a 3.5-point premium, whereas we've seen six-month futures carry near 10-point premiums to VIX at various times in the past year. It's a cumulative effect of futures themselves drifting lower over time, combined with the recent VIX strength. It's likely these futures will barely budge if/when VIX next drifts.

Disclaimer: The views represented on this blog are those of the individual author's only, and do not necessarily represent the views of Schaeffer's Investment Research.

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