Now that the Fed's Out of the Way, What's Next for VIX?

They met, they saw, they deleted the word "patience," and the world survived! Now, as opposed to watching data and eventually raising interest rates, the Federal Open Market Committee (FOMC) has shifted to a policy wherein it will watch the data and eventually raise rates. But, they might raise rates modestly later than someone somewhere thought they would, so buy everything!

At least buy it if the market was down the day before. That's the only real pattern to all of this lately. I doubt that can persist forever, so I wouldn't actually play on that pattern. We did get an outsized range move in the S&P 500 Index (SPX). As I noted the other day, the market had priced in about a 1.25% range on Fed Day. In actuality, we nearly doubled that, so traders that bought SPX or SPDR S&P 500 ETF Trust (SPY) options paper to flip into the move likely did well. But that's far from a certainty.

First off, results always vary. It's very tough to max out catching a range. Odds are, if you faded the morning weakness, you started scaling out well before the top, and likely even shorted into it. Which highlights another point: It wasn't much in the way of up and back. Here's how SPY looked on the 5-minute chart from Wednesday's open to midday Thursday:

So, best case scenario, you sat for 4.5 hours, got a news blip, and then had a chance to close. Beyond that it looks close to a wash. What's more, implied volatility itself got crushed. We knew it would decline; it's the same dynamic as if you owned single-stock volatility ahead of earnings. The stock moves and vol dips, and the bet is whether the magnitude of the move was sufficient to offset the vol dip.

Unfortunately, we have to estimate the volatility dip. And I'd suggest that the vol drop on Wednesday after the announcement exceeded market expectations. The CBOE Volatility Index (VIX) dropped 10.8%, the biggest single-day VIX drop since Groundhog Day (the market didn't think Phil would see his shadow).

So now what? Well, we can start worrying about the next meeting! Or the dollar! What about Greece? VIX near 14 seems neither here nor there, though I'm sure someone on TV will tell me it's incredibly cheap. And yes, it's below 10-day realized volatility. But again, I'd like to make an earnings analogy: Before the news, implied vol lifts. After the report, the move itself causes a pop in realized vol, while forward-looking implied vol contracts. Hence, a seeming disparity that has no particular meaning. Options are already looking out for the next vol driver, not the last one.

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