Predicting the 'Real' Turn in Volatility

Will the CBOE Volatility Index (VIX) call it a wash next year?

by Adam Warner

Published on Dec 30, 2014 at 9:25 AM
Updated on Apr 20, 2015 at 5:32 PM

I've revealed some semi-serious predictions for 2015, but I realize there's probably more value in real predictions. So here we go.

Ask any pundit what he sees for volatility going forward, and he'll say he expects volatility to rise over the next (N) months, where (N) equals "anything." As we've noted, it's both a silly and a sensible call. It's silly because not a soul out there says he expects volatility to drift going forward so long as the CBOE Volatility Index (VIX) is in the mid-teens or lower at the time someone asks the question. It's sensible because, well, the futures curve almost always looks exactly as it does now (click chart to enlarge):

VIX Futures Term Structure

The market itself almost always expects higher volatility. If you really think VIX trends lower -- or even flatlines -- going forward, it makes more sense to just short VIX futures than announce your volatility bearishness. But I'm writing up my prediction here, so I'm going to go the "flat" route. I don't expect VIX to look all that different a year from now. I believe we have about another year or so left in this long-term, low-VIX regime.

That's not to say we sit in the mid-teens all year, though … far from it. We will see volatility spikes; we always see volatility spikes. One of these spikes will become the "real" turn. So, I guess my real prediction is that we're still a year or so away from a "real" turn. Everyone and their day-trading dentist expects Fed tightening this year. That's likely not the source of the volatility spikes we inevitably will see. That's simply because everyone knows it's likely to happen. The actual volatility spikes will occur thanks to something that we don't know or don't worry too much about right now.

A few years back it was fashionable to call every "new" market-moving story a "black swan." We collectively kind of overused and misused that term. I saw a recent list of potential "gray swans" somewhere -- basically stories that will potentially upset our apple cart. That's better, but it kind of misses the point, too. Again, if you see them ahead of time, they're not really black or gray swans.

So, my prediction is that it doesn't add much value to predict what stories come out of nowhere to zonk the 2015 market, and which stories (Russia, Greece, Oil, Fed, etc.) will sporadically "matter." Besides, why ruin the suspense?

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

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