Schaeffer's Trading Floor Blog

Volatility Complex Unfazed by Recent Unrest

We're still probably another good scare away from an extreme in the volatility complex

by 8/7/2014 7:56 AM
Stocks quoted in this article:

As we try to put this week of shaky markets into perspective, we have to keep a few things in mind. None of us are used to unrest off levels this high. A 40-point dip in S&P 500 Index (SPX) futures sounds and feels pretty large, but it's not much more than 2%. Going all the way back to two weeks ago, we've only dropped a shade over 4% from the record highs to yesterday's lows.

But, as we noted recently, volatility levels here don't fully factor in moves of that size. The CBOE Volatility Index (VIX) around 16 prices in ranges under 1% on about two-thirds of days.

Having said all that, we're kind of neither here nor there as far as sentiment is concerned. Put volume is booming lately, but that's not shocking, given the change in market character. Term structures are generally flattening, which also tends to happen during unrest. But it's far from extreme.

Here's VIX vs. the CBOE S&P 500 3-Month Volatility Index (VXV). To refresh, VXV is the same as VIX, except it proxies a hypothetical 90-day SPX option as opposed to a 30-day option.

VXV vs VIX since 2008

It did invert briefly, for the second time since 2011. But it didn't get particularly extreme just yet.

The best explanation is that VIX has lingered on the low end of normal for so long now that VXV finally drifted along with it. And then didn't fully believe the very recent VIX strength.

We usually look at term structure via VIX futures, and that graph hasn't changed all that much (click to enlarge).

VIX Futures Term Structure

I got asked the other day about whether this is going to invert. My answer is that it's not happening so fast. You're really going to need to see the whole board at a discount to VIX, and then have that high VIX persist for more than a couple days.

And I'm not sure that low- or mid-20s VIX is imminent. Here's that above graph again, but with 10-day realized volatility (RV) in SPX included (click to enlarge).

VIX Futures Term Structure with 10-Day RV

Yup, even with all this action, 10-day RV is only in the 11s. The VIX premium of 4 points over that is historically normal -- as is the upwards slope in the term structure, for that matter. So, after all this action, all we really have is an absolutely normal-looking volatility complex.

Long story short, it looks like we're another scare and a volatility pop away from getting to anything resembling an extreme in the volatility complex.

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

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