Why the VIX Could Drift

Realized volatility is declining on the Energy Select Sector SPDR ETF (XLE), which could impact the CBOE Volatility Index (VIX)

by Adam Warner

Published on May 6, 2015 at 8:11 AM
Updated on May 6, 2015 at 8:19 AM

We spend a lot of time parsing all things CBOE Volatility Index (VIX), and -- right here, right now -- there's not a whole lot going on. VIX with a full of 13 excites exactly nobody. It's on the low end, for sure, but it's pretty much in line with our current backdrop of a strong-ish and range-bound market.

But there's a whole wild world of stock and sector volatility out there. Maybe we're missing some more interesting trees in that forest. Or maybe not.

Here's a look at 30-day implied vol (VIX methodology) vs. 10-day historical vol (in some assorted index and sector exchange-traded funds [ETFs]). Also included is the implied volatility (IV) premium to historical volatility (HV), expressed in absolute value.

30-Day Implied Volatility vs. 10-Day Historical Volatility

Well, not a whole lot there. Two huge SPDR S&P 500 ETF Trust (SPY) components -- Energy Select Sector SPDR ETF (XLE) and Financial Select Sector SPDR ETF (XLF) -- have seen a downdraft in realized vol lately. And that has clearly dragged down the broader-based SPY realized vol.

I use 4 points as a general "fair value" IV premium, and as you can see, most names above sit fairly close to that number. There is one standout, though -- XLE, again, which carries a 12.7-point premium. Oil itself has, of course, stabilized in 2015, after a well-publicized implosion in 2014. XLE has behaved similarly, but in a more muted fashion.

On the surface, it looks like options are late to acknowledge that the stock crush and volatility rush have ended, and are in fact a bit overpriced here. In reality, though, it looks more like the options are about right and the realized vol understates the norm in XLE. Implied vol in XLE was under 20 at virtually all times from July 2013 to September 2014. But since then, 20 vol looks more like a floor. Realized vol has behaved similarly -- it checked in over 20 for most of the past seven months or so before the recent cratering.

It's unclear at this point whether that vol spike was a blip, or the start of a more lasting up-cycle in the options. As such, pricing options at a mid-range volatility does seem appropriate. And in XLE, that's about a 20 vol.

It's worth keeping an eye on, though. XLE does comprise a big part of the S&P 500 Index (SPX), so if declining realized vol holds here, it could lead to a drift in our friend, the VIX.

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

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