Consulting the Options Oracle

I nominated myself "VIX Czar" recently. But, ever since we cured Ebola (or, at least, stopped covering it), no one has any interest in czars anymore.

I should have called myself an oracle. I missed my chance, it's too late now, and my friend, Steven Sears, has found someone more "oracular" (or something).

"In ancient days, the Greeks sought guidance from the Oracle of Delphi. In the modern options market, investors wondering about Greeks -- that is, the elements that measure put and call values -- consult Goldman Sachs' Krag 'Buzz' Gregory.

"Gregory, who has four math degrees, including two master's degrees and a doctorate, is Wall Street's wise man whom everyone consults to divine volatility's future. Volatility is the essence of options prices. If you can accurately predict where volatility will trade before it reaches that level, you have a distinct advantage. Imagine how much money can be made if you know today that the CBOE Volatility Index will be 25% lower tomorrow."

OK, in all fairness, he has me by about 3.5 math degrees -- not to mention he laps me 10 times over in incorporating economic data. So, I yield the floor. What does "The Oracle" see for volatility? Mid-10s CBOE Volatility Index (VIX) in December and "lower for longer" going forward.

Well, I don't disagree. As we note often (and he notes as well), VIX carries a rather large premium to realized volatility. Ten-day realized volatility has hovered in the 3s and 4s over the last month or so, whereas VIX has traversed between 12 and 15 for the most part. It normally carries about a four-point premium. There's no arb, but it does have to resolve at some juncture. Either realized volatility should lift, or implied volatility should dip. Options buyers will not "overpay" forever.

Mr. Gregory expects it to resolve via a lower VIX. December is a notoriously non-volatile month, so that sounds like a reasonable expectation. Beyond the holidays, though, it's likely VIX nudges back up again.

Further out in time -- well, investors continue to pay a premium for VIX futures. One of these years, that will look prescient. But, I'm pretty sure I type that same sentence every year. Someone, somewhere always sees VIX at 18 about half a year out. Whoever's doing that right now basically sees a quadrupling of realized volatility, and expects that quadrupling to persist.

What I mean is, he needs a lasting volatility spike, not the relative blips we've seen over the past five years. And that's not a bet with great odds, in my humble opinion.

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