Is VIX Actually Cheap Right Now? (And How Can We Tell?)

Why the CBOE Volatility Index (VIX) looks perfectly fair at current levels

by Adam Warner

Published on Oct 14, 2015 at 8:45 AM

I mentioned yesterday a trading idea I liked now that the CBOE Volatility Index (VIX) is “cheap." That leaves an important question, though: Is VIX actually “cheap”?

Well, using All VIX History as a reference point, it's modestly cheap. As we noted the other day, VIX has an all-time median of 18.05, so we’re a bit under. But in 2015, we’ve seen 71 VIX closes above 16.50, which is only about 36% of all closes this year. So, we’re actually in the high end.

Alas, it's more important to compare VIX to realized volatility. Options ostensibly price relative to volatility expectations. But as we see time and again, VIX does a better job predicting realized volatility that already happened.

Ten-day realized volatility (RV) in the S&P 500 Index (SPX) peaked at 41.76 on Sept. 2. Of course, the actual VIX peak was Aug. 24, so we’re just looking in hindsight. But by and large, RV is rather mediocre this year. Right now, 10-day RV is about 12.50 -- meaning 16.50 VIX is almost perfect, given that it typically trades at a 4-point “premium.”

And that 12.50 level isn’t anything extraordinary. If anything, it's higher than typical this year. How about the 16.50 we see now in VIX? Ten-day RV spent about five weeks above there this year, basically from Aug. 20 to late September. The rest of the year, it's been lower.

So to me, it's tough to make the case that VIX is low. Yes, it's below levels we’ve seen for the better part of the last two months. But it's more or less in line with realized vol, and there’s no particular reason to anticipate RV is about to explode again. I’d call VIX very fair right now.

I think there’s always a sense that VIX is some sort of entity unto itself. And that said entity spends most of its days with its head in the sand, not worried about all these things that the smart folk seem to see. In reality, it's a mathematically calculated proxy of the degree to which the marketplace is willing to pay up to hedge and/or speculate. VIX often gets it wrong, of course. I mean, sell-offs and vol spikes are a regular periodic occurrence (if that oxymoron makes any sense). But most of the time, VIX prices risk about right -- which is to say, it modestly overprices risk. That’s exactly where were are now. I just don’t see it as particularly anything from anything here.

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

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