What's Next for VIX and Oil Volatility?

CBOE Crude Oil Volatility Index (OVX) is still surging, which could impact the CBOE Volatility Index (VIX)

Jan 8, 2015 at 9:25 AM
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Just how wild a volatility ride have we seen in oil? Check out this graph of CBOE Volatility Index (VIX) compared to CBOE Crude Oil Volatility Index (OVX) (the VIX methodology applied to crude) over the past half-year.

VIX vs. OVX since July 2014

Thanks to the recent volatility lift, VIX shows a nice 76% gain over that timeframe. It's the wonder of selective endpoints, of course. But that pales compared to the 232% pop in OVX, which shows scant sign of slowing down.

The real divergence between OVX and VIX took place about three months ago. Since then, VIX is up 17%, and OVX is up 114%. Another way to look at all this is that OVX levels are more consistent with VIX in the low 30s.

I noted way back when this whole oil volatility pop began that oil volatility and VIX would likely converge at some juncture, probably with a small VIX lift and a big OVX drop. That really never happened, as you can see. The disparity between the two now is as big as ever.

That's a scary thought, in the sense that VIX has indeed lifted. Crude won't decline forever -- probably. So let's go on the assumption it bottoms at some non-zero level. Then what?

Well, oil volatility will tank (pun semi-intended). And it would seem like the overall equity market would stabilize, and VIX would decline, too. But perhaps VIX won't decline as much as we think. Oil volatility has just moved so far off the charts that maybe there's a chance this volatility just spills over into another sector or asset class, and VIX holds up.

I don't want to sound like I'm calling for a longer-term VIX lift. I'm not. I mean, it will happen at some point. It's just a low-probability endeavor to say this is THAT point. But probability is a good way to look at it. I would say that the odds of a longer-lasting VIX lift are larger now than they've been in some time.

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

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