I have talked rather extensively about the surprising lack of volatility in the markets during the past month or so, particularly given the sharpness of the current downturn and the preponderance of gloom and doom news out there. For a little while, at least, it was possible to ignore this phenomenon and chalk it up to “calendar reversion.” Now that the holiday season is behind us, this explanation no long holds water and it seems everyone wants to know why the VIX just sits there in the low to mid-20s. For those interested in the evolution of my thinking on this subject, I encourage your to consider reading Not a Lot of Fear or Volatility Lately (11/27/07); No Fear (12/19/07); The Incredible Shrinking VIX (12/21/07); VIX Shrinkage Continues… (12/24/07); The Low Fear Selloff (1/4/08); and VWSI at Zero as VIX Meanders (1/14/08).
The bottom line is that I cannot explain why the volatility indices appear to be relatively indifferent to what many think is the beginning of a nasty bear market. Of course, this relative complacency would be possible only if investors as a whole were not worried about a bear market – and when was the last time that investors failed to panic when the markets turned down sharply?
While I have no answers, per se, I do have a few working hypotheses that I tweak from time to time, in no particular order:
- increased use of inverse and double inverse ETFs (i.e., QID) for hedging/speculation
- the expectation of a forthcoming emergency rate cut limiting upside potential for puts
- the possibility that there has been so much advance warning about a potential market meltdown that those who have wanted to protect their portfolio and/or speculate on a downside move have had ample time to do so, at their leisure
- a vicious cycle in which the less the VIX moves, the less valuable (reliable) it is as a hedge (or highly leveraged hedge)
If and when I can come up with a better answer to this question, I will cut in with a live feed from Volatility Central…
FWIW, Bespoke it out today with a nice chart of the muted VIX phenomenon.
ReplyDeleteA simple answer is that the crowd remains too sanguine, and have not yet gotten too panicky . . .
ReplyDeleteIts not RIP -- just not there yet
Thanks for weighing in here, Barry. Your opinion is consistent with 'conventional wisdom' about the VIX and matches the take that Jay Kaeppel had today. Still, I am not convinced that all bottoms have to be capitulation bottoms with a dramatic VIX spike.
ReplyDeleteI don't think the VIX is dead; I suspect it's just on vacation. IMHO, the VIX will be back, but it doesn't have to hit 35 before the markets put in a bottom.
We could very well have a reversal bottom today with lots of shorts covering tomorrow to get out of the way of the possibility of a pre-expiration emergency rate cut.
Cheers,
-Bill
Goldman Sez:
ReplyDelete1. Absence of demand. The lack of put buying - and vol flow in general - is seemingly inconsistent with price action. I think this is a function that core portfolio risk - both gross and net - is running low in the levered community. the attached chart of “concentrated” hedge fund positions clearly points to steady delevering. Until that turns around who needs puts.
2. the longer dated part of the vol curve - e.g 5yrs and out in the variance space - has seen activity that’s skewed towards selling. Consequently the dealing community is long vega.
3. As mentioned before, equity implieds - both vs realized and vs credit spreads - wasn’t cheap. I think the first factor is getting to more attractive levels; the implied-realized spread in 3-month expiry SPX options is now below average levels of the past year.
Took a stab at it, nice work btw.
1440WallStreet.com
regards,
SJ
hasn't it been relatively normal for the volatility indexes to put in a set of declining tops as the market finds a bottom? seems to me that it did so in mid-2006, mid-2005, mid-2004, march 2003, 2h2002, april-may 2000, late 1997...
ReplyDeleteanyway, though the absolute level is historically not high, i actually thought the VXN put in a very respectable dislocation from its moving averages in august particularly -- and has been making these successive lower highs on lower lows in price since. seems to me that it could be prelude to a significant (bear market) rally, but all the usualy caveats apply of course.
I would be remiss if I didn't also provide a link to a very interesting analysis of the sideways VIX by Marty Chenard: What the Bull and Bear Leadership Stocks are telling us ...
ReplyDeleteI'm with you, Bill, on it not HAVING to make a spike to form a bottom - but ironically, if the index forms a bottom without a spike, my Timing system will continue to call for 50% cash!
ReplyDeleteYou are the second person to present to me (third to present in print, since I passed it to Adam) that the depressed VIX could be simply because those who want protection have ALREADY BOUGHT IT, limiting the demand for options.
I think we have been spoiled with the recent spikes in volatility given the severe lack of volatility from 2003 to 2006. Historically, not every bottom has been hit by a significant volatility spike (although most of the major bottoms have).
ReplyDeleteWith the VIX currently knocking around the 50-day MA and looking good there, a move back to the mid-30s cannot be ruled out.
Until then - keep watching!
DJF
"the expectation of a forthcoming emergency rate cut limiting upside potential for puts"
ReplyDeleteI think this pretty much covers it.
January 28, things have changed quite a bit from what volatility looked like on January 16.
ReplyDeleteI swear sometimes the market listens to our thoughts, then like an wry old man, looks over its glasses, winks, and does something different.
I think the intraday high of vxo (old style) was 37 in the days after Jan.16 and on that basis, was a 3 year high point.