Will Rising Implied Volatility for Oil Spill Over to Stocks?

I'm listening to the TeeVee when I hear a feature on oil volatility and anticipation thereof. My first thought is that, yeah, it was volatile for a few months. But that has kind of abated, albeit at lower levels. And the pundit-sphere tends to overstate volatility. Like we noted last week, it's the rare person that comes out and says they expect less volatility going forward -- in anything.

Silly me, they actually have a good point in oil.

United States Oil Fund LP (USO), which is sort of the iPath S&P 500 VIX Short-Term Futures ETN (VXX) in crude (at least, the way it will drift slowly over time amidst what looks like equilibrium), has had a rough four months. It was 39.44 at its 2014 peak in mid-June. It's now about 29, not too far above its lows near 28 a few days ago. USO's 10-day realized volatility is about 25, almost near the 2014 highs of 28, and well above typical levels in the mid-to-high teens.

For the record, 10-day realized volatility in SPDR S&P 500 ETF Trust (SPY) still carries a 3 full, so USO volatility is downright respectable.

If you told me all this and asked me to guess the implied volatility in USO, I'd expect to see it above-average, given that USO itself is near the lows. But I'd also expect to see it at a discount to the current realized volatility. Mean reversion coming up, right? That translates to something like an 18 "VIX" in USO.

Well, I would have lost a mint selling options at or near that volatility. The USO VIX is now about 34.5, essentially the high for the year. That's somewhat enormous, given that volatility here generally stayed around 20-21 and below until early October.

So I stand completely corrected on this topic. The market truly does anticipate some major price action in oil over the next month.

Will it translate over to general equity volatility? Stocks themselves were moving with some reasonable correlation to crude while the recent shakeout was going on. But that ended about a month ago. Crude has stayed in the doldrums, while stocks flipped the script and took out old highs.

As to volatility spilling over, there's not much sign of that just yet. The equity volatility we know is pathetic. Bond volatility has trended lower as well, though not quite as abruptly. Currencies are meh. The only major spot where we see volatility somewhat elevated is gold, which makes some sense in that it ties into crude a bit.

Oil volatility is definitely something to keep on the radar, but not to obsess much over.

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