Schaeffer's Trading Floor Blog

The Realized Volatility Crash (Or, Why the Low VIX is Still Too High)

What the plunge in historical volatility has done to the options crowd

by 1/17/2013 7:46 AM
Stocks quoted in this article:

Last week, I noted that even though 10-day realized volatility (RV) exceeded the CBOE Market Volatility Index (VIX), it wasn't a signal to go all-in on options, if for no other reason than RV was about to fall:

The 10-day [historical volatility] 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.

Well guess what? The big-range days have officially left the HV calculation. And 10-Day HV has plunged all the way to 5.6.

At a shade over 13, the VIX has hit multi-year lows. So objectively -- in a vacuum -- the VIX is very low. But of course, most of us don't trade in vacuums. The VIX is not low when compared to the current realized-volatility backdrop. In fact, it's quite high.

This is NOT, NOT, NOT to say you should go short options. HV looks backwards and VIX prices look forwards. HV could pick up in a heartbeat, the same way it picked up at the very end of 2012.

That being said, you can't completely disconnect the two. An investor net-buying index options 10 trading days ago has likely gotten clocked. At a 14 volatility -- about the average VIX reading over the past two weeks -- you'd need roughly a 0.9% range in the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) to offset your daily time decay. You've gotten about 0.4%. A directional move in the SPY could bail you out as well (if you didn't actively trade against the position), but that hasn't exactly happened, either. The total range of the SPY over the last 10 days is just 2.25. That's TOTAL. The net move over 10 days is about a $1 rally.

In other words, options ownership has worked horrendously for the first two weeks of 2013. That doesn't exactly encourage options buying going forward. In fact, it emboldens options sellers. Until they get shaken out, they're going to keep selling. Rinse, repeat.

Realized volatility this low isn't particularly sustainable. So the VIX isn't going to single digits any time soon. But it's a bit disheartening to say that realized volatility could double overnight and the VIX still wouldn't necessarily merit a higher price (it would go higher just perhaps not as much as the Pundit Class will expect).

Oh and the iPath S&P 500 VIX Short Term Futures ETN (NYSEARCA:VXX), that bad joke of an ETF? It has a perfect record in 2013. It has made a new all-time low every single day.

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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