Schaeffer's Trading Floor Blog

The Great Volatility Shift

Exploring the current volatility backdrop

by 5/19/2014 7:44 AM
Stocks quoted in this article:

Every Monday for the last few months or so, I've talked about the volatility and market action the week before. Or rather, the lack thereof.

But, as we hear more and more, there's lots of volatility around -- just not where we're looking. The CBOE Volatility Index (VIX) proxies implied volatility on the S&P 500 Index (SPX), but it's all Russell 2000 Index (RUT) these days, right?

OK, let's take a look.

The iShares Russell 2000 Index ETF (IWM) closed at $110.03 on May 9, and by the end of last week, it dropped all the way to $109.57. That's about 0.4%.

Well, guess we're going to have to look a little deeper to find that elusive volatility.

The CBOE Russell 2000 Volatility Index (RVX) -- the VIX of the Russell -- keeps making new relative highs to VIX, as we noted the other day. And it makes financial sense to pay up for small-cap volatility. The 10-day realized volatility (RV) in the IWM is about 19.5, twice as high as 10-day RV in SPDR S&P 500 ETF Trust (SPY). The RVX is 19.5, meaning you're paying no premium to realized volatility in the underlying versus about a 3-point premium you'd have to pay now for SPX or SPY options.

The IWM ranged from a high of $113.04 last week to a low of $107.44, for a range of about 5.1%. In contrast, SPY's top-to-bottom range was a shade under 2%.

So yes, the Russell churned net-net for the week, but there's more than enough fluctuation under the surface to justify the options prices. I could make a strong case that short-term Russell volatility is a better buy than short term SPY volatility, given the respective realized vols. And again, that's with Russell volatility at all-time relative highs versus SPY vol.

I would strongly emphasize that this is only a short-term implied volatility opinion. Right here, right now, the biggest action is in small-cap and momentum names. But that isn't likely to persist forever. And perhaps that's already starting to change. Big-cap financials had a couple ugly days last week, for example.

As to big-cap in general, it was yet another week of no motion. The 2% range we mentioned above is miniscule. And the net move in SPY on the week was all of 0.09%. We moved 0.10% the week before, so we're churning even worse! And to add insult to injury, the pathetic moves offset each other SPY is literally down 1 penny in two weeks. Pathetic.

VIX dropped from 12.92 to 12.44 in a week. Yes, 12 is a low "full," but can you blame it? Until there's some sort of short volatility squeeze, there's no particular reason to buy much in the way of options. Or buy much in the way of VIX exchange-traded notes (ETNs). The iPath S&P 500 VIX Short-Term Futures ETN (VXX) made all-time lows four times last week in other words, back to normalcy.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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