Why the Current VIX is So Perplexing

Friday's VIX implosion was not a good sign

by Adam Warner

Published on Jan 25, 2016 at 9:54 AM
Updated on Jan 25, 2016 at 9:55 AM

Remember those worries about the CBOE Volatility Index (VIX) underperforming in sell-offs last week? Multiply them by 10 after Friday's action. The market recovered nicely, so we would expect to see some sort of negative action in VIX. But not an absolute tanking. Yet here we are.

VIX closed Friday at 22.34. That's unexceptional on an absolute basis, and very cheap vs. even its own recently mediocre self. Thanks to Friday's implosion, VIX is now 11.4% below its 10-day simple moving average (SMA). That's not unusual around something like a holiday or a massive rally off an extended oversold market. But it's not a holiday and it wasn't the biggest dead cat bounce I've ever seen (to say the least).

No, it's odd. So what's going on? Here's some of what has buzzed around:

"It is not entirely clear why fear indicators have not spiked, but investors point to a mix of factors. Hedge funds have been cutting their exposure to the stock market in recent months, reducing their need to protect against losses. New, external shocks have not materialized in this sell-off, which is more driven by well-established worries over oil, China's faltering growth and weak corporate results.

"… overall, the use of options to bet on volatility and the market's direction has declined in recent months.

"'Hedging instruments are not being used as aggressively as you would think,' said Nick Colas, chief market strategist at the ConvergEx Group in New York.

"There are about 6.5 million open VIX options contracts, as of Wednesday. That is about 10 percent lower than when the market bottomed in August and September, and 30 percent below the October 2014 selloff."

I've also seen thoughts that hedgies played for this move ahead of time and are thus sellers of vol into the pop. There's probably a little truth in everything. The net effect is a rather orderly drop minus the fear explosion. That's not intuitively the greatest backdrop if you're rooting for the ugliness to end for real. VIX futures aren't telling us a whole lot right now:

160125Warner1

It's more or less pricing in VIX around here for the foreseeable future. The term structure is a bit flatter than another recent date with similar spot VIX:

160125Warner2

It's not enough to call it "Big Fear" though. Color me a bit worried about the ease with which VIX dropped on the first sign of strength.

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


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