Thursday, June 14, 2007

VIX Implosion Ahead?

Let me start off by saying that I would probably mention Adam Warner and his Daily Options Report more often on this blog, but in doing so I risk the possibility of engaging in an extended baseline VIX rally – and that might put everyone to sleep.

In his usually provocative manner, today Adam is talking about the possibility of a VIX implosion that might send the volatility index back into single digits.

I have chronicled the history of sub-10 VIX closes here in the past, but since February 27th, that subject has fallen off of my radar. First, I’ll start with some historical context. Adam mentions the possibility of the VIX imploding during the next options cycle. At current levels, a one month drop of about 30% would be needed to take us into single digits. While a VIX drop of 30% in one month is not unprecedented, the one month in which it happened, April 1994, came on the heels of 40% and 38% monthly gains in the VIX in the previous two months. Then it was a mean-reverting move; this time it won’t be.

Another factor that argues against a large VIX drop is VIX seasonality. As I have previously discussed, the VIX has a tendency to bottom out in June, before spiking dramatically in July, August and September.

Finally, it is always interesting to look at the implied volatility of VIX options. While these have dubious predictive value (see the lack of advance warning for February 27th in the preceding link, which mirrored the complacency prior to the May 2006 selloff,) it is worth noting that VIX IV is sitting just above the 52 week low.

In sum, while I think Adam’s VIX implosion scenario is highly unlikely, I’ll refrain from saying that it cannot happen. I applaud Adam for going out on a limb and being provocative, but with my VWSI looking out 10-20 days, I see the most likely scenario as the VIX continuing in a range of about 12.50 – 15.00 for the next options cycle. Not an exciting prediction, to be sure, but one which will provide me with an opportunity to harvest some theta.

1 comments:

Adam said...

thanks.

And thanks for the pic, lol.

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