Are We 'Due' for a Volatility Spike?

It's only been two months since the last CBOE Volatility Index (VIX) spike

Mar 10, 2015 at 8:30 AM
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News Flash: Telepundit on a mid-day financial TV show expects volatility to lift in March … or at least be higher in the month going forward versus the month looking backwards. OK, we've gone over this many times. Everybody always expects higher volatility looking ahead than what they see in their rearview. That is, unless volatility just spiked.

News Flash: The markets themselves always expect volatility to lift going forward -- again, unless we already spiked. Here's the CBOE Volatility Index (VIX) futures term structure.

VIX Futures Term Structure

And here is the term structure now versus a couple other recent dates, with VIX near 19 and in an upswing.

VIX Futures Historical Prices

Nothing ever changes. We're a little higher and a little flatter out in time, but it's basically the same sentiment. Both those other dates preceded decent VIX spikes, though. So, should we actually expect one now? It's two months since the last one and that's close in time, generally speaking. We usually see about three to four defined spikes per year, and if I got to the calculator on a non- Apple Watch, that tells me they happen about every three to four months, on average. But they've gotten more frequent over the past year or so. So perhaps we're actually "due?"

VIX is near 15 now … kind of neither here nor there. Contrary to what you hear on TV, a reading under 20 does not mean it's cheap. We've spent most of the last five years under 20. You would go broke assuming a volatility pop on an absolute level alone. Ten-day realized volatility doubled last week … all the way to eight!

So yes, even with the doubling, VIX is still somewhat high looking backwards. If you told me 10-day realized volatility was eight and asked for a "fair" VIX, I'd say "13." The normal premium is about four, but with realized volatility on the low side, I'd splurge and pay a five-point premium.

That doesn't mean 15 VIX is too high, though. But it does mean it's not particularly cheap right now. To me, it's the high end of fair. I got asked Friday whether VIX was under-reacting to the selloff of that day. Perhaps it did underwhelm a bit, but given the entirety of the backdrop, volatility feels in line. We have our usual mix of Fed Fears (omg, they might remove the word "patience" in their next statement), with a dash of Greece and Russia thrown in. The real risk of a volatility pop, though, is something we don't know about yet, or at least aren't pricing in. But since by definition we don't know about it, it's tough to value. And besides, that's kind of why implied volatility trades at a premium to realized volatility in the first place.

This isn't going to get me on TV, but my opinion is that we're pretty fairly priced right now.

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


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