Schaeffer's Trading Floor Blog

VIX Futures are Rising -- But Are We All That Afraid?

Investor fears were higher as recently as two months ago

by 7/23/2014 7:34 AM
Stocks quoted in this article:

Well, we've now officially retraced our non-cataclysmic declines off the highs. And all we got were some lousy t-shirts, and some worthless CBOE Volatility Index (VIX) calls.

… OK, not really.

We did get an overbought VIX signal that may look kind of odd in hindsight. And we got a spike in 10-day realized volatility (RV) in the S&P 500 Index (SPX) -- all the way to double digits!

Yes, 10-day RV "closed" above 10 for two straight trading sessions. July 18 marked the first time 10-day RV went out that high since April 25, so we're talking virtually an entire quarter of single-digit volatility. That's a tough backdrop if you're rooting for a VIX pop. Implied volatility can move separately from RV if expectations going forward change. But over time, it's tough to get anyone to pay up for options when they keep losing money on the trade.

And as Eli Mintz of VIX Central notes, not all RV pops are created equal. In regards to the recent "surge," he tweets:

That's a fair point. Volatility, in theory, is independent of direction. A big range on an up day looks the same as a big range on a down day to a dispassionate calculation such as RV. But, clearly, we react entirely differently. No one's afraid of a string of large up days. We don't react to a 1% pop by purchasing every cheap VIX call in site. But if we go down 1% … watch out!

What's more, that RV "pop" looks even less ominous when you consider that it's entirely thanks to Friday's virtual retracement of Thursday's big dip. A trader watching every tick felt a 1.25% dip, then a 1.1% pop on consecutive days. An investor not paying all that much attention felt a 0.1% yawner over two days. Extend your horizon to four days and we haven't moved at all.

So who has a major need for protection after all that? Really, no one, unless you're worried about future volatility. But that's always the case.

And we are collectively less worried now than we've been in quite a while. Here's the VIX futures term structure now vs. two months ago, when VIX itself was at a similar level.

VIX Futures Historical Prices

The market still expects a rising VIX over time, just not nearly to the extent it did as recently as two months ago.

Throughout the bull move, the term structure was a sign of fear and disbelief in the rally. That's still the case -- there's really no particular reason for much of an upslope -- but it's a case that's gotten much weaker over time.

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

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