Saturday, December 31, 2016

The Year in VIX and Volatility (2016)

The consensus called for a big uptick in volatility in 2016 and while there was a lot of drama, the VIX spikes were relatively manageable and short-lived.  The VIX opened the year at 22.48 and ended the year at just 14.04.  For the full year, the median VIX was 14.31, while SPX historical volatility for the full year ended up at a mere 13.12.

That being said, there were five distinct VIX spikes in the graphic below, listed according to chronology:
  • Fears related to slowing growth in China (January)
  • A plunge in crude oil prices to $26.05/bbl. for WTIC, as investors grappled with the possibility that Cushing storage facilities would be exhausted (February)
  • The surprise Brexit vote result in favor of the U.K. leaving the E.U. (June)
  • A cocktail of nearly simultaneous shocks from Fed President Rosengren (suddenly sounding hawkish), Jeff Gundlach (interest rates have bottomed) and the European Central Bank (no additional stimulus) puts pressure on stocks (September)
  • Increasing uncertainty leading up to the U.S. election (November) 

In all five instances, the VIX moved up sharply, but in defiance of historical precedent, the volatility index moved down almost as sharply as it moved up.  In fact, some of the biggest extremes for the year came in the form of volatility crushes, where the VIX had an unprecedented series of sharp downward one-day move.  Checking the record books, the only previous year that the VIX posted three top 20 one-day declines was 2007 – and clearly investors were in denial that year.  This year the Trump election caused the sixth largest one-day drop in the history of the VIX, whereas the Thursday before and Tuesday after the Brexit vote triggered the eighteenth and tenth largest one-day VIX declines.

On the other side of the ledger, some of the upward moves in the VIX made the record books as well.  The day following the Brexit vote saw a 49.3% VIX spike – the fifth highest one-day spike on record.  What was even more surprising was the Rosengren/Gundlach/ECB cocktail noted above triggered a 39.9% spike (eleventh highest in history) in what seemed to be a relatively calm market environment in September.  It turns out the VIX was just getting warmed up for greater things, including a record nine consecutive up days leading up to the November election.

Even with these extremes, the highs and lows in the VIX were rather middling, with the VIX peaking at 32.09 on January 20th and hitting an annual low of 10.93 on December 21st.

The graphic below captures these and other highlights from 2016:



[source(s): StockCharts.com, VIX and More]

Included in the non-VIX highlights are a 5000+ year low in interest rates in Europe and Japan (where negative interest rates prevailed) as well as a thirteen-year low in the price of crude oil.  On the geopolitical front, political craziness of one kind or another abounded in Brazil, South Korea, Turkey, Italy, Colombia and South Africa, among other locations.  Terrorism also left its footprint again in 2016 and Zika also created considerable political and social turmoil.  In the financial realm, European banks had a very difficult year and begin 2017 on shaky footing.

While the year ended on a relatively quiet not, I suspect 2017 will have much more in the way of new surprises, including swans of many dark hues.  Next week I will resume the VIX and More fear poll and find out what the consensus is for volatility and its causes in the coming year.

Finally, since 2011, I have been maintaining a proprietary Macro Risk Index that measures volatility and risk across a broad range of asset classes, including U.S. equities, foreign equities, commodities, currencies and bonds.  In 2016, the Macro Risk Index was trending down most of the year, punctuated by significant spikes in February (crude oil) and again in June (European currencies). 

How did 2016 measure up to expectations?  I sum up the year in My Low Volatility Prediction for 2016: Both Idiocy and Genius.  Also worth investigating are a pair of Barron’s articles from one year ago laying out two opposing perspectives on volatility in 2016.  For the case for rising volatility and what to do about it, try Jared Woodard’s Prepare for Rising Volatility in 2016.  I provide the contrarian point of view in The Case Against High Stock-Market Volatility in 2016.

Have a happy, healthy and profitable 2017!

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For those who may be interested, you can always follow me on Twitter at @VIXandMore

Disclosure(s): the CBOE is an advertiser on VIX and More

Friday, December 30, 2016

My Low Volatility Prediction for 2016: Both Idiocy and Genius

A year ago, Steve Sears of Barron’s asked me to pen a guest column for The Striking Price and use the opportunity to opine on how I saw the volatility landscape unfolding in 2016.  Without thinking about it too much, I was fairly certain I was going to devote the column to the many threats that had the potential to spiral out of control during the course of the year, but before I had an opportunity to start translating my thoughts into writing, other pundits started weighing in with their predictions for 2016 and without exception, everyone who ventured a guess on the direction of volatility was adamant that volatility would be substantially higher in 2016 than 2015.

Not wanting to follow the herd and always on the lookout for a more provocative point of view, I decided to fade the consensus, rip up the script in my head and adopt a contrarian outlook:  The Case Against High Stock-Market Volatility in 2016.  The column began as follows:

“Looking at all the market predictions for 2016, one thing is certain: Almost all of the pundits agree that volatility will be up, making a bet on rising volatility one of the year’s most popular trading ideas.

But, as is the case with much of the investment landscape, when most of the pundits agree about how the future will unfold, it pays to investigate the contrarian point of view.

As to volatility, the contrarian perspective is particularly compelling for 2016 because volatility is notoriously hard to predict; investors have a habit of dramatically overestimating its future level; and, when it comes to forecasting the causes of volatility, “experts” and investors alike have a penchant for fighting the last war.”

Then came January.  For those who have tried to put it out of their memory, January was one of the worst first months on record, with the S&P 500 Index falling 7.3% for the month.  The bearish trend continued into February, as fears related to China and crude oil had investors selling en masse.  By the time stocks found a bottom on February 11th, the S&P 500 Index was down 11.4% -- by some measures the worst beginning for stocks in history.  Volatility, of course, was spiking and the VIX had already topped 30.00 on three separate occasions just seven weeks into the year.

My prediction of lower volatility:  complete idiocy.

But the year was not over and we still had to grapple with Brexit, the crazy and unpredictable election season in the U.S., a Fed interest rate hike and persistent political turmoil in places like Italy and Brazil.  Amazingly, stocks showed a tremendous amount of resiliency and all the VIX spikes were given the Whac-A-Mole treatment as VIX mean reversion emerged as a key theme during 2016.

Now that the year is (almost) in the books, it turns out my contrarian low volatility prediction was spot on and the rest of the pundits ended up on the wrong side of a crowded losing trade, assuming one was patient enough to take a full-year perspective.  Genius?  Probably not, but definitely more right than wrong, despite my having to wear a dunce cap for the first two months of the year.

The graphic below shows the annual average VIX and historical volatility going back to 1990.  Note that while the average VIX fell from 16.67 to 15.83 this year, there was an even larger drop in realized or historical volatility, which fell sharply from 15.53 to 13.14.

[source(s):  CBOE, Yahoo, VIX and More]

As far as takeaways are concerned, there is the obvious lesson regarding the herd mentality and crowded trades.  Additionally, there are also issues regarding how investors frame a problem or potential problem.  For example, when one expects an increase in volatility they are more likely to be overprepared for that development and/or overreact when there are initial signs of an increase in volatility.  Ironically, if investors load up on SPX puts or VIX calls, then this makes it much more difficult for panic to filter into the market.  This leads to a theme that has been repeated often in this space:  VIX spikes are notoriously difficult to predict and it is also more difficult to anticipate a change in volatility regimes than many believe.

Last but not least, as the graphic above shows, predictions of future volatility almost always overshoot realized volatility, which is why in the last 27 years only the extreme turmoil in 2008 saw realized volatility higher than the VIX over the course of a full year.

As for 2017, when it comes to volatility, expect the unexpected.

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For those who may be interested, you can always follow me on Twitter at @VIXandMore

Disclosure(s): the CBOE is an advertiser on VIX and More

Thursday, December 29, 2016

Average VIX and Volatility for Last Fourteen Presidents

What kind of VIX is appropriate for the Trump Administration? 

For investors in general and volatility traders in particular, this is one of the more interesting questions going into 2017.  Should the VIX be higher or lower in the context of a Trump Administration relative to the Obama Administration?  How much economic policy uncertainty is there in Trumponomics?  How will various geopolitical issues wax and wane in the context of a Trump-Tillerson foreign policy agenda?

While these questions are difficult ones, what is not difficult is looking in the rear-view mirror for some historical context, so that is exactly what I did, calculating the historical volatility for each presidency going back to the Hoover Administration.  In order to take advantage of stock data prior to the 1950s, one has to make use of the DJIA rather than S&P averages.  While VIX data is even more interesting, the VIX was not launched until Bill Clinton’s inauguration and historically reconstructed data from the CBOE only extends back to George H. W. Bush’s presidential term.

The results of the number crunching are included in the chart below and show Herbert Hoover’s historical volatility of 42.87 more than double that of the runner-up, Franklin Delano Roosevelt who posted a historical volatility of 20.88.  The only other president to top the 20 level in terms of historical volatility was George W. Bush at 20.28.  At the other end of the spectrum, the least volatile presidency was that of Lyndon B. Johnson, where HV averaged an amazingly low 9.12.  Following LBJ on the low end are Dwight Eisenhower at 10.70 and Harry Truman at 12.20.


[source(s):  CBOE, Yahoo, VIX and More]

Among recent presidents, three of the last four presidencies (George W. Bush is the exception) have seen middling volatility, with Barack Obama 6th of 14 as of today’s data, while Bill Clinton is 7th and George H. W. Bush in 8th place.

Since the eye canot help but see trends and patterns whether they exist in real life or not, I am obliged to observe that since the LBJ presidency there is a pattern of higher highs and higher lows.  Could volatility by presidential term be trending up?  I am certainly not ready to go that far.

In terms of key takeaways, it is worth noting that the median historical volatility (combining data from Bill Clinton and George H. W. Bush) indicates that a middle-of-the-road presidency can expect historical volatility of 14.65 and a VIX of 18.91.  As far as the VIX is concerned, the 18.91 number aligns nicely with current VIX futures quotes for May and June 2017.

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For those who may be interested, you can always follow me on Twitter at @VIXandMore


Disclosure(s): the CBOE is an advertiser on VIX and More

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