What We Definitely Maybe Know About VIX in 2015

After a big drop in February, what's next for CBOE Volatility Index (VIX)?

Mar 2, 2015 at 9:04 AM
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Remember all those predictions that 2015 would see a return to "normal" volatility? Yeah, not so much anymore. As we noted the other day, the CBOE Volatility Index (VIX) has had its worst calendar month ever. And it's still overpriced. That's because realized volatility has utterly collapsed. Ten-day realized volatility in the SPDR S&P 500 ETF Trust (SPY) is now 3.9, roughly 30% of VIX. And that's high realized volatility compared to the iShares Russell 2000 ETF (NYSEARCA:IWM), which now checks in at an almost incomprehensible 3.1.

Just to quickly review: 4 volatility translates to two-thirds of trading days seeing a range of 0.25% or less in the underlying index. A volatility index looks forward, and (rightly) prices in an uptick in volatility. But over time, options owners lose money if they keep overpaying versus the actual volatility, so the numbers will converge, in some fashion, somewhere down the line.

So, does this "prove" all those 2015 volatility calls are wrong? Of course not. Volatility moves up and back over time, but never really gets anywhere. It mean-reverts. The "mean" eventually changes, but it's a slower process than we all give it credit for. We saw an up-wave all of about a month and a half ago. Now we're seeing a down-wave. It's probably safe to conclude that the mean really hasn't changed just yet. In other words, we're probably still in a low-volatility regime, though likely at the tail end.

But rest assured, all 2015 volatility calls still have a good chance of proving correct. It just depends on your metric. The VIX itself closed 2014 on an up-wave, ending the year at 19.20. So, there's a very good chance it will close down in 2015. Mean and/or median are a better gauge of VIX over a given time frame. Median is better, in my honest opinion, in that the mean can get thrown off by a few outliers.

Anyway, the VIX median in 2014 was 14. The 2015 median could very likely go out above that. I would have called that a "definite" a few weeks ago; I'll have to downgrade that to a "definite maybe" now.

These are just two ways to judge volatility. There are others (and other volatility indexes, for that matter). Regardless, it's likely we can get different answers depending on how the question is presented. But it shouldn't really matter. I did call for 2015 to see increased volatility on a median basis. I'll stick with that and say this is likely a down-wave in a slowly increasing volatility world.

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


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