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Everyone's always saying that the CBOE Volatility Index (VIX) is "too high" or "too low" … it never seems to be "right." And really, it's rarely considered "too high."
The consensus always says it's too low, and that it's a sign of too much complacency and a harbinger of big declines ahead. Setting aside that a low VIX isn't really the best market signal, my question is, what is the "right" level?
The answer is that VIX is "worth" whatever the masses are willing to pay in implied volatility terms for a normalized near-the-money option on the S&P 500 Index (SPX) with 30 days' duration. In other words, there is no "right" value.
What are the Los Angeles Clippers worth? Forbes Magazine said something like $550 million. Steve Ballmer said they're worth more like $2 billion. And since he's the one forking over the actual cash, we'll go with that $2 billion figure.
Now of course there are real-world numbers like cash flow and the possibility of future revenue growth that suggest that $2 billion was a crazy price. But if someone's willing to pay X for an asset, that logic suggests that asset is actually "worth" X.
VIX has real-world metrics to price off too. We can look at the realized volatility of the market now, and "predict" realized volatility going forward and come up with a fair price for implied volatility. Over the course of time, implied volatility prices at about a 4-point premium to the recent past realized volatility, so by that metric, VIX is pretty fairly priced right now.
But what if the market as a whole expected future realized volatility to explode and the VIX was something like 20. Would that make the VIX "wrong"? Not really, it's simply the value the marketplace is assigning to future risk.
So if VIX is always priced exactly what it's "worth," then what's the value in looking at it?
Well, for a good amount of time, there's not enormous value. It merely tells you something you already know. There are times though, like the example above, where the market is seemingly too worried. And even though VIX is technically "right," it's a signal that there's a bit too much worry in the system, and that will often (but not always) resolve in a strong rally.
My point really isn't about those times though, because that's certainly not what's happening now. Rather, it's that there's absolutely nothing to suggest that today's "correct" VIX is in any way wrong. I don't believe VIX trading near 11 is "bullish" or "bearish," it's just a reflection that the market isn't overpaying for risk protection at a time when there' s really no reason anyone should pay up much for risk protection.
Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.