Schaeffer's Trading Floor Blog

Mike Piazza, the VIX 'Rebound,' and More Statistical Noise

What happens when the Fiscal-Cliff Effect rolls out of the VIX's 10-day HV calculation?

by 1/10/2013 8:33 AM
Stocks quoted in this article:

Big rally in the CBOE Market Volatility Index (VIX) yesterday, according to… well, Zero Hedge. It's factually correct, but (shockingly) kind of misleading. Let's do a quick breakdown:

After record-breaking compression and six consecutive drops in VIX (along with a morning full of further compression) spot VIX is bleeding higher now.

It was record-breaking compression by a couple of measures that we've noted this week. And it did bleed higher, more like a tiny paper cut, though. I mean a 0.2-point rally all the way up to… almost 14! That's after the so-noted compression. The words "dead-cat bounce" come more to mind.

Having caught 'down' to stocks' ebullience yesterday, it appears the hedgers are either covered or rolled further out but there is another reason perhaps (aside from the absolute cheapness of protection).

Speaking of "having caught," Mike Piazza really got lost in this whole Baseball Hall of Fame hysteria, no? I mean, obviously he's lumped in with the 'roid users because he had big stats and Clemens once threw a fastball at his head… and then a bat at him. Oh, and he had alleged back acne, which allegedly means something.

But whatever, I digress. Let's Go Mets.

I eagerly await "another reason" to explain what's basically statistical noise. This pup isn't designed to impart wisdom at every micro-tick.

Quantitatively, the implied volatility of the S&P 500 is now below its recent realized volatility (this difference is really a better indication of how fearful or fearless investors are)…

Emphasis his.

He's absolutely correct. VIX sits near 14, and 10-day realized volatility in SPX is in the 17's. But I can't emphasize enough that the relationship between these two measures is somewhat informative, but virtually never deterministic of anything. IV prices forward, HV measures backwards. The 10-day HV calculation still incorporates the big range-day moves on Dec. 31 and Jan. 2 as the Fiscal Cliff UnLoomed. Meanwhile, IV dropped precipitously from the pre-Fiscal Cliff bid-up.

It's the exact same dynamic any time a company reports earnings. IV jumps ahead of HV into the number. Post-number, IV drops. If the stock moved, then HV picks up. IV may now show a big discount to HV, but it really has no meaning.

… and on each of the previous three occasions that has occurred in the last year, VIX has risen notably relative to realized in the next few days.

And magically, it's going to happen again in a few days. The Fiscal Cliff Effect will no longer be in the 10-day HV calculation, and thus, HV will perform poorly vs. IV, proving him correct. It's as bold an observation as saying tomorrow will be Friday.

Look, he's right in his macro point. VIX has dropped precipitously. But comparisons to HV right now are very much apples to oranges, and not a great way to drive the point home.

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


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