Why is the VIX so Low?

A number of theories have been kicked around recently to explain why the VIX is at historical lows.

Justin Lahart re-ignited this debate with his comments in the WSJ yesterday in which he offered the explanation that:

“The VIX and other measures of implied volatility are low, in part, because investors are selling put and call options — ’selling volatility’ in Wall Street parlance. That helps to drive option prices — and implied volatility — even lower.”

Bernie Schaeffer takes issue with Lahart’s analysis this morning in www.SchaeffersResearch.com, arguing against both the low VIX theory and the likelihood that selling volatility is the cause. Schaeffer cites the recent extremely tight trading range of the OEX as proof that the VIX can go much lower. He also maintains that a large majority of the option activity in question has been initiated by buyers, not sellers.

Striking a similar note, Adam at the Daily Options Report draws comparisons between the current VIX and the range-bound VIX of the early to mid-1990, suggesting that the 10-15 range may be the natural long-term range of the VIX.

As mentioned previously in this space, Jason Goepfert of www.sentimentrader.com has attempted to reconstruct the VIX going back all the way to 1900 and believes that the current VIX readings are not particularly low by the historical standards of the past century.

Finally, in my first entry in this blog, I proposed that the VIX had moved in four macro cycles in the 14 years since it first appeared, with a typical length of 3-5 years per cycle. According to my analysis, the current cycle of decreasing volatility began in April 2002, so the five years will be up in another two months or so.

I have no prediction for what will happen to volatility two months from now and beyond, but I will do my best to use this blog to present the various theories of why the VIX is low and refine my own thinking as I go along. In the meantime, I will continue to fade any large spikes and continue to work the bear call spread angle.

A Challenge to Two Things You Think You Know About the VIX

From Jason Goepfert via the virtual pen of Steve Sjuggerud and archives of Investment U and comes several VIX-related ideas that are worth mulling over 1 ½ years after they were published.

Goepfert, who heads up Sundial Capital Research and sentimenTrader.com, attempted to reconstruct what historical VIX data might have looked like if it were possible to simulate VIX readings all the way back to 1900. In this manner he developed what he calls a Faux-VIX that looks back over a century. As described by Sjuggerud, Goepfert determined that while current VIX readings look quite low by the historical standards that cover two decades of official CBOE VIX/VXO data, looking back to 1900 with the Faux-VIX, it appears that volatility readings below the current 11 level happen approximately one third of the time.

Further, and consistent with the initial post in this blog, Goepfert concluded that sustained periods of high volatility tend to alternate with lengthy periods of low volatility in cycles which average approximately five years. Much to my surprise, Goepfert then concludes that “buying the first large spike in volatility has paid off time and time again.” This contrasts sharply with my current thinking, which favors capitalizing on the mean-reverting tendencies of the VIX by fading large volatility spikes.

In future commentary, I will examine the degree and duration of various types of volatility spikes and return to Goepfert and the fade-or-buy-the-spike debate.

Note: For those who may be interested, Goepfert is a frequent contributor to Minyanville.com and archives of his articles on that site can be found here.