Will This Volatility Pop Outlast the Financial Crisis?

CBOE Volatility Index (VIX) futures suggest traders expect this round of volatility will outlast that of the financial crisis

by Adam Warner

Published on Sep 3, 2015 at 7:58 AM

How ugly have we gotten lately? Well, here's how the heat map looked on my trading screen on Tuesday:

150903Warner1

OK, I can't actually do a screen grab on that screen; TOS won't load on my Chromebook, so I substituted a picture of Mars from that Schwarzenegger documentary "Total Recall." But you get the idea.

Out of 500 stocks in the S&P 500 Index (SPX), nearly all of them were down. It was yet another 90/90 down day. And of course the overall damage continued to accumulate even though we have yet to retest the lows (so far). Here's the percentage of S&P stocks that are trading below their 200-day moving average, going back to 2007:

150903SPX200day

Chart courtesy of StockCharts.com

We're down to 21% -- the worst level since 2011, and the second-worst since 2009. It's important to note that the market drop in 2011 was nearly double the drop this go-around so far, and even the drop in 2010 was bigger, about 15%. It suggests the damage to portfolios is worse than the indices would lead us to believe, which is also consistent with all other breadth numbers floating around now. 

So, is it any wonder that the VIX complex is starting to "believe" in volatility? Here's CBOE Volatility Index (VIX) futures on Aug. 26, two days after the Big Melt, vs. VIX futures yesterday morning before the big rally. In both cases, the VIX itself was near 30.

150903Warner3

The lift in the Septs was pretty inevitable in that they're closing in on expiration, but beyond that it's not a given VIX futures would react like this. We basically lifted 3 to 4.5 points across the whole term structure, which is rather huge. Remember -- these aren't "bets" on actual market volatility in the here and now. Rather, they're de facto "bets" on the sustainability of the VIX lift.

A week ago, on the heels of a large market move and a historically swift VIX pop, VIX futures pretty much lagged. A mere one week later, futures took the vol pop way more seriously. 

Granted, they were all still at discounts to VIX itself. But it's very unlikely VIX stays near and above 30 for nine months; it didn't even go on that long in 2008-2009, and that was by far the longest sustained VIX pop in history. Mid-20s is still a "high" VIX. 

Look at it this way: VIX has spent most of the last five years in the teens, yet longer-dated VIX futures almost always anticipated a pop to the 19-20 area. At its nadir, long-dated VIX futures got to about 18. Now, about two weeks into the market ugliness, long-dated VIX futures are in the mid-23s. 

The market's generally ugly now and certainly volatile, that's a given. And we're not making up all the losses in the next few days. But it's early to start assuming some permanence to the vol lift. I'd generally want to sell volatility time spreads now.

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


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