In a surprisingly candid note out of derivatives strategist Rocky Fishman, the Goldman analyst - whose employer has a base case 2019 price target of 3,000 for the S&P - notes that in light of recent market performance, the current VIX, which is trading just around 25, is "unusually low" for the 14% selloff the S&P has suffered from its Sept 20 high.
As Fishman calculates, in every other 10%+ selloff in less than three months since the VIX was created, the VIX hit a peak closing level of at least 28, and crossed 30 at least once intraday (naturally that would suggest an even lower S&P, one which sees the index price in the mid-2,400 range).
In other words, all else equal the VIX has at least 3 more points of upside and realistically, 5 or more points, before sentiment normalizes.
It's not just historical performance that hints at a higher VIX however: for one thing, Goldman notes that 2018 has already been the SPX’s most volatile year since 2011, with 16.1% realized vol to date. Here Goldman highlights the increasing volatility in recent history, pointing out that the SPX has had several more 16%+ realized vol years over the past 25 years than it had over the previous 50 years.
There is a reason of course why the VIX soared in 2018 after what was the quietest year on record in 2017, when the VIX printed in single digits for a record number of day: a big reason for the spike in vol is due to the VIXtermination event in February which saw the biggest ever spike in the VIX and when volatility overshot economic fundamentals.
So while Goldman expects high volatility to continue for the near future, and the bank's model mapping economic conditions to realized vol points toward a modest increase in volatility for 2019, this may result in flat year-over-year realized vol if liquidity conditions improve and vol falls in line with fundamentals.
Meanwhile, even as the VIX has been rising, if not enough, SPX skew has fallen sharply, and as the chart below shows, it is well below the past 4 years’ high-skew range. Paradoxically, according to Fishman, a lack of demand for tail hedges has been a likely contributor to this move which is surprising considering the broader jump in realized and implied vol... almost as if traders aren't at all concerned about "fat tail" risk, or are hoping it happens just so the Fed has a reason to stabilize markets...
Finally, some other notable "dislocations and observations" in vol space from the Goldman strategist who incidentally is recommending 46-48 VXX call spreads and far out of the money SPX call spreads to take advantage of the coming jump in volatility:
- Low skew is far from global. Asian indices which usually have lower skew than the SPX have had skew trending upward - in effect converging with the SPX's. US single stock skew continues to be at the high end of its range.
- A byproduct of low skew is low variance-ATM convexity. Variance swap prices are at a lower-than-usual premium to at-the-money options.
- Vol-of-vol is not particularly high – but low skew is consistent with lower vol-of-vol. This year marked the highest realized vol on record (going back to 2005) for the SPVXSP, the index behind rolling VIX futures strategies. Realized vol-of-vol was high enough to get mentioned by Dallas Fed President Robert Kaplan in a recent interview. This realized vol-of-vol has helped keep the VVIX in an elevated range, as it has been for much of the last two years. However, low skew is consistent with a lower level of vol-of-vol.