What Happens When The VIX Spikes, But Traders Aren't "Actually" Worried?

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by Tyler Durden
Tuesday, Feb 27, 2024 - 08:00 PM

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The S&P500 looks like it is entering into a digestion phase into the key March OPEX, which could result in the VIX breaking back down to year-to-date lows. 

Into Thursday’s (2/22) record SPX close near 5,100, 1-month SPX skew showed that upside strikes (i.e. calls) had relatively higher IV's than at any time vs last several months, as shown by the skew plot (below, green line) being above the shaded cone (red box). 

However, the IV's for upside strikes did not increase into Thursday’s 2% SPX rally, which is shown by the current skew (green line) staying flat to Tuesday's close (gray line). This signals that S&P call buyers didn't chase strikes >5,100 into Thursday’s record move.

Clearly Wednesday nights NVDA’s earnings bolstered concerns about right tail risk, and trader’s feared missing upside. To this point the magnitude of yesterday's move held up ATM vols (i.e stock up/vol up & the VIX didn't really "crush"), but the left tail (OTM puts) - we'll that is getting crushed.

You can see this in "indexified" measures like VVIX, or SDEX, shown below. The SDEX measures the relative IV of a put 1 standard deviation move lower in the SPY, which is now back near all-time lows.

We think that SPX call skews are now likely to flatten, with the VIX likely to start sinking as the pace of higher S&P500 prices slow down. 

To this point, both Monday & Tuesday’s 0DTE ATM SPX straddle was just $20, or a scant 39bps! We can't recall having seen the 0DTE straddle priced at such tight levels in the recent past, and it suggests a broad level of complacency and trust in the current market paradigm. 

In regards to a 39 bps straddle, we refer to this as "priced for perfection", as there is nearly no edge for a straddle seller. Any slight market movement, in either direction, can force the seller offsides and cause a cover trade that exacerbates local, jumpy volatility. Jumpy volatility works both ways, and so if traders were still worried about upside SPX performance its not reflecting in short dated straddle prices.

Despite these low 0DTE prices, and to the concept of “stocks up, vol up”, the VIX has only recently pushed back below 14, after holding higher into all time SPX prices.

This relatively higher VIX has been supported by 13.8% 1-month SPX realized vol (green) and 15% 5-day SPX realized vol (red) which are up near highs last seen in November.

Recall that over the last month the SPX is ~4.5% higher, and so volatility is increasing as a result of higher SPX prices. 

What is now interesting about this dynamic is that a VIX of ~14 implies ~88bps daily SPX moves, which is a stark contrast to the 39bps priced into the 0DTE SPX straddle.

This divide between the SPX implied move (88bps) from the VIX and the 0DTE pricing "perfection" (39bps) is likely the result of Thursday AM's PCE reading, which is the big data point this week. The 0DTE crowd does not have to worry about that print for 3 more sessions, whereas the VIX is pricing in some higher volatility. Assuming the PCE is not some type of hot tail print, we think the VIX and SPX volatility will now likely start to move lower into March OPEX (3/15).

We can get a sense of volatility shifts via the SPX term structure, which shows relatively higher short term IV’s due too both Thursdays PCE print, and Friday’s ISM print (red box). However, following this print, at-the-money SPX IV’s sink to ~9.5% (red arrow).

Assuming that PCE and ISM do not produce tail prints, we think that options positioning will likely build around the 5,100 level, which will constrict realized volatility. This will in turn serve to drag down forward volatility measures, like the VIX.

Accordingly, we highlight the 3/15 OPEX time frame as a potential place for volatility to tick back up due to large options positions expiring and rolling across both the index/equity landscape, but also the VIX. 

The plot below highlights the current size of call delta notional (orange) and put delta (blue) for the S&P500 - and as you can see the positions are quite substantial.

To hear more of SpotGamma's thoughts on upcoming volatility - join us tonight at 8pm EST for a webinar on the VIX - Free VIX Webinar