Tuesday, February 19, 2008

Interest in VIX Waning?

A number of readers have wondered whether the recent lack of volatility in the VIX in the face of a strong market downturn indicates that the VIX is losing some of its relevance. This is a fair question.

As the graphic to the right indicates, not only is the implied volatility and historical volatility of the VIX currently hovering near 52 week lows – when clearly investor fear is not similarly lax – but since about mid-November or thereabouts, the volume of VIX options traded has dropped dramatically as well. In fact, with the benefit of hindsight, it appears that the popularity of VIX options surged from May through November of 2007, only to have recently returned to the levels that preceded the anxiety over the subprime problems and all the dominoes since uncovered that appear to have been within tipping range.

Of course, if the VIX’s beta starts dropping below historical levels, it is possible that we may have a situation in which, as I described previously, the less the VIX moves, the less valuable (reliable) it becomes as a highly leveraged hedge against long market positions.

One of the theories about the lack of action in the VIX is that those who are looking for another way to have a highly leveraged hedge have flocked to the inverse and double inverse ETFs. Did anything happen in November that might support that theory? Well, lo and behold, it turns out that the most popular of the double inverse ETFs, the QID, just happened to start trading options in November. Coincidence? I suspect not. While the volume of QID options relative to VIX options is rather small, clearly the game has changed.

This observation is not going to persuade me to change the name of the blog, but don’t be surprised if you see me posting about the QID more often. After all, as the chart on the bottom shows, QID volume (and on balance volume) has demonstrated considerable predictive potential over the past year.


Bill Luby said...

For the record, options were also first offered on SDS (-2x the SPY) as of November. The volume in these options, however, has not comparable to that of the QID: SDS options.

I can see that puts available in QID + SDS would certainly put a dent in the activities of those who preferred VIX options because of the leverage (approx. -4x for the VIX) they offered. Not only that, but in terms of cheap portfolio and, the movements of the QID and SDS are a little more transparent and predictable relative to the major indices than that of the VIX, which might make them a more attractive alternative on that basis alone.

nodoodahs said...

Yes, interest in (and the predictive power of) the VIX is waning.

Just like it did several OTHER times this same scenario has played out in the last 18 years or so.

Unknown said...

You may have something here, Bill... and if we include the volumes of the ETFs themselves (i.e., not just their options volumes), the impact on VIX volumes by hedgers could be noticeable.

Still, I doubt that the VIX is going away as a liquid, heavily traded product. The potential for it to spike up BIG should the market tank will continue to be an attractive feature for many hedgers looking for leverage... at least I hope so. I'm biased, I love the product. :)

Since cash VIX reflects the implied volatility of the SPX, I think it will continue to be relevant and useful... I don't expect traders to lose interest in SPX options, though of course anything is possible. :)


Anonymous said...

The Vix options implied volatiliy levels are often so high that one would be better off purchasing OEX, SPX or other options to hedge positions. For instance, the I.V. levels for the February 30,32.5 and 35 puts at the close of trading on Wed Jan 23rd (the trend reversal day for the U.S. markets) were 141, 153 and 163.5. The I.V. levels for the March 30, 32.5 and 35 puts on this day were 125, 136 and 146. It would be quite challenging for an investor to profit much on VIX put options with such high implied volatitiles.

The implied volatilities for the Feb 30, 32.5 and 35 call options were only 53, 63 and 69 at the close of trading on January 23rd. This is quite the contrast to the implied volatilities of 141, 153 and 163.5 for the Feb 30, 32.5 and 35 put options at the close of trading on January 23rd.

The Vix options I.V.'s for the close of trading on February 20th are still skewed. For instance, the I.V. for the Mar 20, 22.5, 25 and 27.5 calls are 114, 99, 94 and 91 and the I.V.'s for the March 27.5, 25, 22.5 and 20 puts are 46, 49, 49 and 47 at the close of trading today. Similar skews in I.V. exist for the April VIX options as the April 20, 22.5, 25 and 27.5 calls have I.V.'s of 83, 75, 74 and 76 and the April 27.5, 25 and 22.5 puts have I.V.'s of 52, 48 and 48 at the close of trading today.

The SPX March options do not have similar skews between their call and put options. The SPX closed at 1360.03 on February 20th and the March 1350, 1360 and 1370 calls had I.V.'s of 21.4, 21.0 and 20.6 at the close of trading today and the March 1350, 1360 and 1370 puts had I.V.'s of 24.4, 24.0 and 23.6 at the close of trading today.

An investor may want to purchase SPX options rather than VIX options to hedge stock or portfolio positions since their implied volatilities are not as skewed or as high as the Vix options.

Bill Luby said...

Good points, anon. Add together high IV/time decay, large skews, mean reversion, etc. and VIX options can quickly become more more unwieldy than alternative hedging vehicles such as options on ETFs and indices.

Bud Haslett said...

Sounds like your IV numbers are being calculated off of spot VIX and not the VIX futures that the VIX options trade off of.

Bill Luby said...

Thanks for posting this observation, Bud. Yes, iVolatility's VIX IV calculations are run off of the spot VIX, not VIX futures. To your point that VIX options track VIX futures, one should consider iVolatility's VIX IV numbers as directionally correct, but not necessarily the best set of numbers around which to build a VIX options trading strategy.

You have indirectly raised considerable food for thought...



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