VIX Volatility Still on Hold

A funny thing happened on the way to a January volatility spike. Absolutely nothing.

In the chart above the brown line is the 30-day SPDR S&P 500 (NYSE: SPY) implied volatility (IV) versus 20-day historic volatility (blue). The CBOE Volatility Index (VIX) more or less tracks 30 day IV here, printing modestly higher because it gives greater weight to out-of-the-money (OTM) puts than this IV number does. At least we assume that’s the case, the IV formula is proprietary.

The IV sits around 15, which of course sounds quite low. Remember the rule of 16? If you divide any volatility reading by 16, it tells you the percentage range we expect to see in the underlying each day. So a 16 volatility implies that on an average day we will see a 1% range in the SPY*. That’s all of 1.30 points, not much when you consider it can gap that much fairly simply.

Look at that graph again. A volatility of 15 does not look so cheap when you compare it to historical volatility of about six. That’s the pace SPY itself has moved over the past 20 trading days. Clearly if you net sold SPY options 20 days ago and simply traded stock against it you would have done quite well.

But alas, that only tells you how it would have worked; it speaks nothing of going forward. And VIX itself does not even tell the full story. VIX futures expect the VIX itself to shoot higher. For example, April VIX trades at 23. Even factoring in that 23 VIX overstates implied volatility for at-the-money (ATM) options, suggesting that the market expects actual volatility in SPY/SPX to more than triple over the next three or so months. That’s enormous optimism (for options) or enormous pessimism (for stocks). (more)