Six Sanity Checks For A Seemingly Virtuous VIX

Tyler Durden's picture


As short-term volatility leaks lower and lower and more and more talking heads use this 'risk-index' as reason to be longer and longer stocks, we thought it might be useful to get some context on recent movements in volatility-related factors. Whether its seasonality, volatility term structure, or the high-yield credit market, VIX looks low (underpricing short-term risk). Perhaps it is a plethora of new-year-new-book covered call euphoria or just belief in the LTRO firewall fixing tail-risk (or US decoupling shifting us to moderation), short-term options are sending some different messages to the risk-is-on-like-donkey-kong 'broadcast' that the contemporaneous (and in no way leading) VIX is being mis-understood as indicating. We present six perspectives that should be considered before more nickels are picked up in front of the micro (earnings) and macro (you name it) steamroller.

First, VIX is considerably seasonal. The chart below shows the average drop is short-term volatility has been very impressive into year-end and indeed for the first week or two fo the new year there is little to no pick up from this seasonal. By week 3, seasonals show that VIX picks up notably. Is all this VIX compression, simply a December/January-effect on VOL? inferring the seasonals would mean a higher VIX is about to begin?

Second, demand for index protection remains much stronger than it seems underlying single-names suggest as implied correlation diverges from VIX. Whether this is covered call writing en masse or simply the market makers and professionals more than happy to carry the crash risk (knowing something we mere mortals do not?), implied correlation (which measures the relative demand for index volatility versus the volatility of the underlying names in the index) has risen consistently in the last week or so even as Vol has dropped notably. This divergence tends to revert with Vol moving to implied correlation (in this case VIX higher).

Third, compared to the high-yield credit market, vol is considerably too low. It would be hard to argue that the high-yield credit market did not better reflect real-money investor's greater-than-short-term risk-appetite for well, risk, given the huge skew to getting-it-wrong in credit. The tight relationship between HY credit and volatility (which is inherently non-linear and dynamic but for the sake of simplicity we track in this chart) has broken in the last few months and short-term volatility is not at all pricing similar risks to the HY market. Arguing that perhaps HY should revert lower is a stretch also when one reflects on the market participants' attitudes, real-money, size, and perspective. Perhaps HY is not pricing the impact of an inevitable QE3 as much as vol? We suspect the truth is somewhere in between and vol will rise.

Fourth, the term structure of short-term vol to medium-term vol is very steep which has tended to infer over-optimism and a rapid reversion to higher short-term vol levels. The relationship between 1m and 3m vol for stocks can provide some insight into just how over-excited all those premia sellers are. It seems the natural momo players from stocks have found a new home and chase vol lower and lower, selling more and more premium, until of course, crack. It would appear that both the steepness (i.e. short-term vol is very low compared to medium-term) and absolute levels of vol suggest that maybe those picking up nickels in front of the steam-roller need their knuckles rapped once again.

Fifth and Sixth are related to the differences between a normal distribution and the real distribution of returns implied by options prices for SPY (the S&P 500 ETF). If we create a more complex model for valuing options (away from the Black-Scholes model) then we can 'calibrate' this model to understand how skewed (left or right skewed - i.e. how much upside/downside risk is expected) and how kurtotic (a big word for fat-tailed or how much extreme risk is expected).

The implied kurtosis (which really reflects what the options prices are saying aboutthe risk of extreme moves) is showing that both long- and short-term  indications are for a rising expectation of extreme moves. This rising expectation is perhaps what is helping price the index vol (implied correlation above) higher than the underlying micro vols...the point being that under the surface, extreme risk expectations are rising (which is not what VIX is reflecting).

The implied skewness (which is different from the skew in vol that many are used to thinking about) is calibrated by adjusting the underlying distribution of returns to meet options prices. In the case of SPY, we can see longer-term expectations of notable downside skew rising significantly in the last week or two (in fact the highest (lowest on chart) since the US downgrade). Short-term options do indeed reflect the lower concern of downside as they have risen recently but remain around the median for risk and are also notably divergent from longer-term options. After profit-taking on skewness positions as we crashed in Q3 2011, short-term options skewness does not reflect the move in stocks and longer-term skewness is much more concerned at downside.


All-in-all, it would appear that when we scratch at the surface of VIX, we find some notable references for why it has dropped (seasonals, HY compression, profit-taking on complex options, covered call writing?) but perhaps more importantly the clear picture is one of an instrument (short-term vol as VIX is untradable directly) that has been pushed too far and risk-reward on the risk-index seems skewed to significant upside from here.

Charts: Bloomberg

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Tue, 01/17/2012 - 16:21 | 2072076 LawsofPhysics
LawsofPhysics's picture

Again, technicals don't matter.  Come March, the VIX will start to look cheap as paper continues to lose "value".

Tue, 01/17/2012 - 16:26 | 2072091 SeverinSlade
SeverinSlade's picture

Just tell the Sheeple that the VIX is bullish for equities.  There, now you're on the same page as CNBS.

Tue, 01/17/2012 - 16:51 | 2072202 SheepDog-One
SheepDog-One's picture

Hmmmm yes....we'll totaly manipulate the markets so there are no drops, make 'VIX' go to -0-, then use that as proof of how good things really are and prove how cheap stocks are.


Tue, 01/17/2012 - 16:26 | 2072092 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

Yeah!  What Tyler said.

Tue, 01/17/2012 - 16:28 | 2072101 5880
5880's picture

Firms are telling everyone to overwrite calls, but HV is still lower than IV. The VIX isn't whacky low, it's reflecting the real underlying vol

Tue, 01/17/2012 - 16:29 | 2072106 fonzannoon
fonzannoon's picture

I was starting to get a little excited. That little butterfly twang of excitement. Then 3pm hit and the market went on it's daily run to the close.

Tue, 01/17/2012 - 16:29 | 2072109 jarboejl
jarboejl's picture

I love that the the S&P 500 can't hold that all-important 1294 level, even with a +14 pt running start at the open!!

Tue, 01/17/2012 - 16:47 | 2072185 fonzannoon
fonzannoon's picture

we mushed it

Tue, 01/17/2012 - 16:37 | 2072134 5880
5880's picture


nobody has used Black Scholes since the 80's

cox ross rubenstein is the base model

Tue, 01/17/2012 - 16:42 | 2072155 Everybodys All ...
Everybodys All American's picture

It is my contention that the Fed is flattening the VIX much as they are the yield curve. I can't prove it but it sure trades that way.

Tue, 01/17/2012 - 17:01 | 2072245 Stoploss
Stoploss's picture

Up 6% today.. ?? And a five point S&P spread to go with it. Hold the mayo.

Tue, 01/17/2012 - 16:51 | 2072207 scatterbrains
scatterbrains's picture

I'm noticing the put writers index is diverging from the SPX much like it did just before the 08 crash...  any thoughts ?

Tue, 01/17/2012 - 16:54 | 2072222 SheepDog-One
SheepDog-One's picture

Tough to say....back in '08 if someone said 'Dont worry, if stocks drop, we'll just print up $2 trillion dollars and throw it at the stock markets to fix it' the whole country would have gone apeshit.

Today? Just normal operating procedure.

Tue, 01/17/2012 - 16:56 | 2072229 5880
5880's picture


that you should look into what the PUT actually is

Tue, 01/17/2012 - 17:01 | 2072248 scatterbrains
scatterbrains's picture

I'm thinking it's success breeds complacency.

Tue, 01/17/2012 - 16:59 | 2072241 LawsofPhysics
LawsofPhysics's picture

If that correlation holds it also suggests a significantly larger drop as well.  But I digress, what was volume then as well.  Vapor trading bitches.

Tue, 01/17/2012 - 17:04 | 2072258 LongSoupLine
LongSoupLine's picture



What do ANY of these pretty charts have a flying fuck to do with central banks being the market??

Oh yes, I used to be a technical guy...slo sto's, CCI's with timeframe crossing name it, I had it nailed.  Now all that shit is worthless.  This is purely a "market" of shadow banking, overleveraged fake liquidity, and perpetual backdoor bailouts for ANY downside threats.  Fuck it, just buy silver!

Tue, 01/17/2012 - 17:09 | 2072281 Frank N. Beans
Frank N. Beans's picture

i've got kurtosis of the liver, bitchez

Tue, 01/17/2012 - 18:08 | 2072464 HyperLazy
HyperLazy's picture

At 15:59:27 CT, volume on TVIX hit 800,000 in one transaction. Oh my. LOL

Someone know something we don't?

Edit: Seriously, thats a big frickin' block, eclipsing TVIX's volume all day in one swoop!

Tue, 01/17/2012 - 19:41 | 2072727 POpatriot
POpatriot's picture

I don't see anything close to that on my graphs...  

Tue, 01/17/2012 - 19:53 | 2072751 HyperLazy
HyperLazy's picture

I stand corrected, my bad. I had woken up several moments previous to that transaction and in my groggy stupor had posted in haste. It was surprising to see that 11% of TVIX's volume today took place in one moment after market. But still, who has the moxy to swing 800,000 shares of TVIX at once and why????? *ponders in futility*

Tue, 01/17/2012 - 20:30 | 2072815 Excursionist
Excursionist's picture

Hmmm... "..a plethora of new-year-new-book covered call euphoria.."  Reminds me of the exchange bewteen El Guapo and Jefe:

El Guapo:  Would you say I have a plethora of pinatas?
Jefe:  A what?
El Guapo: A plethora.
Jefe:  Oh, yes!  You have a plethora.
El Guapo:  Jefe, what is a plethora?
Jefe:  Why, El Guapo?
El Guapo:  But you told me I had a plethora, and I would just like to know if you know what a plethora is.  I would not like to think that a person told someone that he has a plethora and find out that that person has no idea what it means to have a plethora.


Tue, 01/17/2012 - 20:59 | 2072877 razorthin
razorthin's picture

And yet some sukkers still fall for it.  Like dollar-cost averaging.

Tue, 01/17/2012 - 21:26 | 2072915 El Hosel
El Hosel's picture

Gee Wally, 

 Did'nt The Bernank testify under oath that he was targeting volatility / rigging the stock market?

...and didn't Littly Timmy just get the ECB and China to start firing their own Bazookas at the " Markets"?

.... and now the US marktes are hanging up here near last years highs as the rest of the world starts to (finally) play along and print?

..... how the fuck are the markets ever going red, I wanna be a Bear for fucks sake! ???

Tue, 01/17/2012 - 23:12 | 2073248 doomz78
doomz78's picture

i accumulate gold and silver stocks..  the vxx on the tsx is on my radar.  its at 30$/share.  its been at 20-65.  Yeah I could buy it now.  

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