VIX is "searching for a new home" according to Goldman Sachs as the current elevated level of implied risk lies at the high side (around 24) of the current business cycle (~18) and recession-esque volatility (~26) range. Current options prices imply a 7% chance of a 10% crash in the next month and uncertainty is running twice as high ahead of this week's jobs data than on a normal payrolls week...
The VIX is searching for home. An indecisive VIX curve is waiting for data.
Clarifying comments from Fed Chair Janet Yellen, an upward revision to second quarter U.S. GDP to 3.9% and a higher than expected increase in consumer spending were still not enough to hold the market up last week. The S&P 500 was down 1.4% last week and the VIX landed at 23.6. The VIX has averaged 22.4 over the last week and that is an interesting level.
An indecisive VIX is searching for a new home: Relative to the current levels of ISM, employment, and consumer spending we estimate baseline VIX levels of 18. 26 is the median daily VIX level over the last three recessions. An average VIX level around 22 over the last week is therefore midway between our business cycle estimate for the VIX and the median VIX level over the last three recessions. That is about as indecisive as the VIX has been in years. The VIX is searching for a home.
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A flat VIX term structure also points to an indecisive vol market waiting for data. Oct-15 to Apr-16 VIX futures are also all within a vol point of 22. In the good times, the VIX term structure is upward sloping. When equities are at their worst the term structure becomes inverted, with the VIX much higher than the VIX futures. A flat term structure with no momentum in either direction signals extreme indecision, in our view.
While the economy may suggest VIX levels in the high teens, a primary take-away is still that baseline volatility levels have shifted at least 4 points higher than average VIX levels in 2014 (14.2). While we wish the VIX a speedy recovery, in our view an indecisive VIX is justifiable. The market is searching for improvement in U.S. and global data. We get ISM and payrolls this week.
What are the odds?
SPX options are pricing a 7% chance the market is down 10% over the next month.
After the drop in implied volatility and skew from a local peak one-month ago the S&P 500 options are now pricing in a 7% chance the S&P 500 declines 10% over the next month
And this week is extremely volatile...
While payrolls may be the headline release this week, if the market is focused on growth, then Thursday’s ISM release may also be highly watched. Consensus stands at 50.5 for the ISM print, our team expects a drop to 50, down from the current ISM level of 51.1. A print below 50 may not be helpful for the bulls.
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The S&P 500 straddle expiring Friday October 2nd captures both the ISM and payrolls and is pricing in a +/- 2.4% S&P 500 move over the next week.
The S&P 500 has been down on seven of the first nine payroll release days in 2015. The straddle breakeven of +/- 2.4 corresponds to a fairly pessimistic S&P break-even range of 1885 and 1978. While the straddle price is down from a local high of 4.7% in August, the expected move of +/- 2.4% is 1.7x its median level 1w prior to payroll releases over the last year (Exhibit 3 above). The average daily absolute return on the S&P 500 has been 1.3% since mid-August and 46 bp over the last week, so the options market is pricing in an added cushion, even relative to recent S&P moves.
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Source: Goldman Sachs
