Gamma is King – watch the JPY

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In late December we saw the VIX explode to 35. VIX at 35 is basically “pricing” 2.2% daily moves in the SPX. Most investors don´t even know that VIX at 16 is pricing approximately 1% daily move, and even fewer think about it before they buy hedges in panic.

Since that “crazy” high print VIX, the index has been falling and is today trying sub 20 for the first time since early December (VIX at 20 is pricing some 1.2% daily moves in the SPX).

The longer-term average in VIX is still lower, but since the October sell off started, the 20 level has been somewhat of a “new normal” average, if not even a relatively low reading.

 

Below is a chart showing the SPX implied vol (blue) as well as the realized 10, 30 and 60-day vol (white, orange, green). Note that implied volatility seldomly trades much lower than the above mentioned realized vols. On a longer-term average basis VIX usually trades lower, but post the “panic” we have seen during the autumn, implied vols are not overly expensive given what the index is realizing.

We have no huge take on longer term volatility, but given the way index moves, gamma is starting to look relatively cheap here.

 

The below chart shows the SPX term structure today (orange) and 2 weeks ago (green). The entire curve has shifted down, but note how extreme the shift has been in shorter term maturities. Short term options have not been this cheap relatively speaking in several weeks.

What we have seen is a classical reverse panic among investors where the crowd ends up buying short term protection in panic, overpaying for gamma, only to see these hedges implode. Most investors are then once again proved that “hedge only cost money”. That is true for the late investor, especially as many of the mainstream banks usually recommend these types of hedges at wrong times (We have written extensively of when the prudent investor should hedge their books, definitely not when the panic is in full motion. For reference click here and here).

 

We continue showing the VIX futures curve, 1st versus 6th month. The curve reached a panic high in late December when markets were in free fall mode and in our note from December 22nd we suggested we were approaching capitulation mode and that a subsequent bounce was to be expected.

The VIX curve has recently been coming in a lot. The “natural” average is lower, but unless you think all is great and a new huge bull market has started, shorter term maturities are starting to look interesting, at least for the long gamma people.

 

Markets are feeling rather calm over past sessions and there are not many macro events that seem to bother investors. Maybe we are a bit old fashioned but one of the biggest risk indicators on our global watch remains the JPY. We had the huge flash move earlier in January, but despite the bounce, this great macro risk indicator seems not willing to join the bullish camp.

Below chart shows the JPY (white) versus the SPX (orange) since October 2018. Bullish or bearish, but don´t forget watching the mighty JPY cross.

Source; charts by Bloomberg