The VIX has increased on nine consecutive sessions, a new record; and the term structure of SPX implied volatility is now steeply inverted, pricing in a potential wide swing over election week. However, as Goldman Sachs notes, although the VIX is up, the market hasn’t actually been moving that much and that has led to one of the largest VIX dislocations on record. In fact, VIX has overshot its typical beta to the SPX by 5 vol points.
After the jump in shorter-dated risk, the term structure of SPX implied volatility is now steeply inverted, pricing in a potential wide swing in the S&P 500 index during election week (Exhibit 1).
S&P 500 options are pricing in a 3.2% move over the next week
Exhibit 2 shows the typical VIX level heading into election-day and compares that with the recent VIX pattern. A VIX of 22.5 puts it about five vol points above the median closing VIX level on election-day of 17.6 back to 1992.
The typical pattern is a VIX rise moving into election-day with the median VIX level declining from 17.6 on election-day to 15.2 one week post-election. Although the VIX has risen substantially over the last two weeks, the S&P 500 has not had one move greater than 1% over the period. In fact realized market volatility remains extremely low. That has led to one of the largest dislocations between implied and realized volatility on record.
But, the volatility risk premium approaches record ahead of the election - VIX is trading at 3.7x its normal spread to realized vol.
Although the VIX has jumped to 22.5, the market hasn’t actually been moving that much and that has led to one of the largest VIX dislocations on record. As we mentioned last week, it is not uncommon for investors to buy option hedges ahead of a potential market moving event. But that doesn’t come for free. The VIX typically trades at a premium to realized market volatility to compensate vol sellers. An analysis of the VIX – SPX 1m realized volatility spread can offer clues as to how much risk premium the options market is baking in, or how complacent the market really is. A VIX on the rise during a period of muted realized volatility has led to a large dislocation between implied and realized vol.
- S&P 500 10-day and 1-month trailing realized volatility measures stand at 5.3 and 6.8.
- The VIX - 1m realized volatility spread is currently 15.7 vol points (22.5 vs. 6.8). That is a 99.5 percentile ranking back to 1990 and 3.7x higher than the average spread of 4.2 points back to 1990. That implies the spread has only been wider on a meager one-half of one percent of trading days back to 1990.
- If the VIX was tracking its typical spread to 1m trailing realized volatility then the VIX would be trading at 11, or about one-half its recent level (6.8 one-month realized vol + 4.2 vol point spread = 11 VIX).
Our point is not that the VIX should be 11. Dislocations can close in many ways. If the options market is correct and a high VIX is justified, then the market needs to drop considerably. If the large VIX moves are unjustified then the wide dislocation between the VIX and realized volatility could result in a quick drop in the VIX and a rise in the S&P 500 if election uncertainty declines, as we expect.
VIX has overshot its typical beta to the S&P 500 by 5 vol pts. The S&P 500 suggests a VIX level of 17.4, not 22.5.
Nine-day VIX rise is a new record…but did the VIX move too much? The VIX has pushed higher for a record nine consecutive days but is the 9.5 point rise since October 24 justified? One way to gauge whether or not recent VIX changes have been “fair” would be to run regressions of the daily VIX change back to daily S&P 500 returns. We can then add up those predicted changes over time to allow us to estimate if the VIX over- or under-shot its typical move relative to the market.
- The beta between daily VIX changes (in vol points) and daily S&P 500 returns has been -1.4 over the last year, implying the VIX moves up 1.4 vol points for every -1% decline in the S&P 500.
- The VIX is up 9.5 points since October 24. We estimate that the VIX has overshot its typical beta to the S&P 500 by 5.1 vol points since October 24 when the VIX was 13.
- That equates to estimated VIX level of 17.4 on November 4 versus the actual closing level of 22.5. The VIX is baking in a tremendous amount of additional risk premium ahead of the election, suggesting the next VIX leg up or down will depend upon the election results.
Presidential Positioning: Friday Nov 4 a record volume for VIX puts
VIX options: The VIX seems high relative to S&P 500 realized volatility and has overshot recent SPX moves by around five vol points, according to our estimates. Both of those statements suggest the VIX is set up for a large decline if uncertainty declines post the election. The VIX options market seems to agree. More VIX puts traded last Friday than on any other day in history.
S&P 500 options: Although volatility levels have been rising, S&P 500 option volumes and open interest have not been extreme. If we look over the last couple of weeks since volatility started to rise then the ten-day moving average of total S&P 500 option volume stands in its 74th percentile relative to a one-year history. The same metric for put volume, call volume and put-call ratios are in their 75th, 58th and 70th percentiles.
We estimate that 6% of the total outstanding open interest is expiring just after the election on Wednesday November 9 or Friday November 11. Wednesday November 9th, the day after the election, has 1.5% of the total open interest outstanding.