Are Volatility Pops Becoming More Frequent?

The CBOE Volatility Index (VIX) finish in 2014 could be misleading

Jan 5, 2015 at 8:51 AM
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On Dec. 24, as the market settled in for its year-end snooze, CBOE Volatility Index (VIX) sat at 14.37, up 0.65 point on the year. With a slow week expected, it was highly likely that VIX would drift and we would see those meager gains disappear. But, alas, the market crumbled in the last week, and, of course, volatility exploded.

OK, scratch that -- the market didn't actually crumble. SPDR S&P 500 ETF Trust (SPY) essentially did nothing for the week into the Dec. 30 close, then dropped 1% on the last day of the year. That's far from an implosion.

VIX, however, did pop big time. The VIX closing 2014 at 19.2 means that we end the year with a whopping 39% gain, and that's a year that saw SPY lift 11.3%.

In a vacuum, that's a huge lift in Fear. And yes, we did see more VIX (and realized volatility) pops than we have in the recent past. But by and large, realized volatility did not look much different in 2014 than it did in 2013. So, why the uptick in apprehension?

Well, maybe there's less to that uptick than meets the eye. In 2013, we saw an average VIX reading of 14.24, and a median reading of 13.75; 2014 saw an average VIX of 14.17 and a median VIX of 13.67. In other words, the typical day in 2014 looked indistinguishable from 2013.

Rather, what we have is a VIX rally that only looks impressive because of the arbitrary endpoints. Pick any random day in 2014, go backwards one year, and VIX probably did nothing on average.

The main effect of VIX closing so strong is that it's going to look misleadingly weak in 2015 on year-to-date comps. Unless, of course, the market crashes, in which case a few VIX points won't alter the narrative much.

None of this takes away from the oddity of the end-of-year VIX strength. Again, the market action hardly justified a 30% VIX pop. So we're left wondering: "What did someone see out there that merited a rush to options?" Is it just a function of a slow market with no real sellers out there? Friday saw a lower VIX on a modestly lower market, so the divergence corrected a bit. But, we're still a bit out of whack.

I suppose we'll see. It does feel like the volatility pops are becoming more frequent. We're barely three weeks removed from the last one, and here we go again.

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

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