Just When You Thought It Was Safe, China Strikes Again

The correlation between the VIX and the FXI

Adam Warner

Aug 20, 2015 at 10:07 AM

Just when you thought the waters were safe, China strikes again. Shocking, I know.

As Matt Moran of the Chicago Board Options Exchange (CBOE) notes, implied volatility (IV) on the iShares FTSE/Xinhua China 25 Index ETF (FXI) has exploded (again) this week. We're certainly higher than the norm, but still a bit away from spike levels of a July.

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Ten-day realized volatility (RV) in FXI is about 24 now, so mid-30s IV seems pretty reasonable, given the action over there. RV reached a high of 64 back on July 10, and remained super elevated for about a week before gradually dipping back into the teens. We're clearly way off the panic levels from back then.

An optimist could say, "That's a good sign, as we're starting to discount the China market implosion a bit." A pessimist could say, "OMG, what if the vol gets back up to July levels? Sell everything! Ask questions later."

For 99.9% of us, it's more important how this all impacts our markets. We didn't rally exponentially with China back in the spring. Rather, we were busy worrying if Greece was going to blow up the eurozone and tank the world economy. Now we've turned the channel to the China Network.

It's kind of instructive to see how the CBOE Volatility Index (VIX) looks vs. FXI vol:

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Before April, the vol indices moved in lockstep. Then China vol spiked and we pretty much ignored until June. At that point, FXI really spiked, and we started following it pretty much tick for tick. And we are still following. Here's how that same chart looks when I start it three months ago:

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Yes, our options literally move tick for tick now with FXI options.

This won't all end with China settling down. It's just not happening overnight -- I mean, they might rally overnight, but it's likely their shakeout persists. It's only going to end here when we decide Chinese economic contraction is discounted here.

We could, theoretically, then rally … But who am I kidding? In 2015, all that means is that we started obsessing over some other burgeoning economic disaster.

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

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