Schaeffer's Outside the Box Blog
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Warning: Second-derivative stuff to follow.

Okay it's not that scary, it's a listed index.

I'm talking about the "VIX of VIX" (VVIX - 78.59), the index of the implied volatility of CBOE Market Volatility Index (VIX - 15.87) options. That's right, it uses the VIX methodology and applies it to options on the VIX itself. Since virtually the entire VIX order flow consists of calls, the VVIX handily indexes the premiums investors are paying for those calls.

Why bring it up?

Well, VVIX now sits at all-time lows near 78. "All-time" unfortunately only goes back to last April, when this product was listed. But alas, we can go back much further if we simply chart 30-day implied volatility of the VIX. And the volatility of volatility has not seen levels this low since March 2010. So it's indeed been a while since investors had this little urge to pay up for VIX calls.

Now before you go all "complacency" on me, consider a couple of things. VIX options have a positive skew. That is, the higher the VIX strike, the higher the implied volatility. VIX methodology weighs near-the-money options more than out-of-the-money (OTM) options, so thus, if the VIX itself is at a low level, than those lower-volatility options will carry greater weight in the index.

In English -- the implied volatility of VIX December and January 17-strike calls carry much more weight in the VVIX than the VIX December and January 27-strike calls. If VIX were to rally a bit, OTM calls like the December and January 27s would carry greater weight. Even if the volatility of calls like that did not budge, an index such as VVIX would rally merely due to the increased weight of the higher-strike calls in a steeply positively skewed product.

And that's a bit of what has happened here. The VIX is nestling in a relatively low level -- and futures premiums contracting a bit -- has the self-fulfilling prophecy of moving the VVIX a bit lower. The VIX itself shows signs of complacency, and the VVIX is more a byproduct of that than an indication of much onto itself.

As we noted the other day, demand for VIX futures and OTM VIX calls remains strong. It's just not reflected in all this.

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

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