Wednesday, September 12, 2007

The VIX and the Fed

Since nobody was reading this blog when I first posted about the VIX and FOMC meetings, I thought I might use next week’s highly anticipated FOMC meeting as an excuse to flag some research I published earlier in the year.

Perhaps the most important piece of information on the VIX and the Fed is a study I have placed in the Archive Highlights section of the blog with the title “VIX Price Movement Around FOMC Meetings.” If you follow the link, you can see why the odds favor a substantial volatility contraction on Tuesday, when the results of the meeting are announced, as well as another smaller volatility contraction on Wednesday, after the information has been digested overnight.

While I am on the subject of the Fed and Archive Highlights, I would be remiss in not pointing out what I consider to be the best set of links on the Fed available on the internet, which I have archived in “Fed Links.”

One other blog link is worth flagging here, the rather innocuous sounding “Options Expiration Calendar,” which resides in the VIX and Sentiment Links section in the upper right hand corner. The reason I mention this link is to remind all interested parties that one of the idiosyncrasies of VIX options is that they do not expire on the third Friday of every month, like equity, index and many other options. Instead, 9 months of the year VIX options expire on the Wednesday after the third Friday of the month; 3 months of the year they expire on the Wednesday before the third Friday of the month – right in the middle of options expiration week. As you can see in the calendar linked above, this early VIX options expiration pattern happens at the end of each quarter in March, June, September and December. This means that VIX options expire the day after next week’s big FOMC meeting, with a special opening quotation (more on this another time.) Even more important, the last day for trading these VIX options is the day before they expire. So anyone holding VIX September options will have exactly 1:45 following the Fed’s announcement to close out their positions. Given the high expectations going into the Fed meeting, it will be very interesting to watch the VIX action – as well as the action on the VIX September options.

So while Tuesday will be a particularly busy day for me, remember that you don’t have to play unless the odds are in your favor. When in doubt, get neutral and watch the action for free from the sidelines.

2 comments:

Morning said...

Great post on the VIX and the affect it has up into the FOMC meeting. However I have a question about the 2 graphs you posted on this in Januaury. Was the top graph the one you constructed? Did you also construct the bottom graph? Which one is the more recent one? Both graphs are saying something different, so I want to make sure I am understand what I am looking at. Thanks

Bill Luby said...

G'morning, morning.

Both of the two graphs from the January 28th post are of my creation. The top graph, which shows the large volatility drops on the day of and the day after the FOMC announcement, uses data from 1990-2007. The bottom graph, where the drop in volatility is concentrated on announcement day, only uses data from June 2004-2007.

Note that I made an edit to yesterday's post to emphasize that the volatility contraction is most likely to be largest right after the Fed announcement, though there is considerable precedent for another contraction in the next trading session as well.

I hope this helps.

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