BX closed Monday trading at $22.86,down 0.85 with IV30™ up 3.9% in a market that saw the VIX fall again (by 1.2%). The LIVEVOL® Pro Summary is below.
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Let’s start with the Skew Tab for BX, below, to examine the month-to-month and line-by-line vols.
Lots of colors and lots of lines, but with a little direction it’s actually not convoluted at all. At $23 on the horizontal axis (which is ATM) go up from the bottom curve (green). The colors you will hit in order are:
(1) Green
(2) Blue
(3) Pink
(4) Brown (or whatever color that is)
Translating those colors to expiries reveals a pattern:
(1) Sep 2012
(2) Jan 2014
(3) Mar 2014
(4) Jan 2015
Or, in English, as we move from shorter expiries to longer-term expires the volatility monotonically moves higher. So the option market reflects more risk in a rather orderly fashion from the short-term through the intermediate-term and into the long-term.
OK… Is this unique to BX? Actually, no… And there are several ways to see this. Let’s start easy – let’s look at VIX options and back out the futures’ price.
Assuming essentially zero interest (which for this purpose is acceptable) we can see that the VIX forward price is higher with each expiry. Quick, back of the envelope math:
Forward VIX price = Strike + Call – Put
------------
Oct Forward VIX price = 16 + 1.65 – 2.20 = 15.45%
Nov Forward VIX price = 16 + 2.25 – 1.95 = 16.30%
Dec Forward VIX price = 17 + 2.30 – 2.47 = 16.83%
Jan’14 Forward VIX price = 18 + 2.47 – 2.80 = 17.67%
All of those levels are remarkable given that VIX spot closed at 11.84% today, but in any case, we see the same monotonicity. Further out = higher expected vol. So, BX is behaving like the broader market.
Let’s look at a BX and SPY vol chart (which is roughly equivalent to a BX vs. VIX chart) and let’s only focus on further out terms: IV120™, IV180™ and IV360™.
The greenish guys are BX the bluish guys are VIX. But focusing in each group by themselves, we can see that for both: IV120™ < IV180™ < IV360™. Again, further out expiries show greater vol. Looking a bit more myopically we can see that the spread between IV180™ and IV360™ is greater than the spread between IV180™ and IV120™. Or, in English, the one-year implied vol for both the VIX and BX show greater divergence from the half-year implied vol than the 120-day implied does. The real question then becomes, is vol really going to rise as we go further out in time? Well, there’s reason to believe it will, and the five-year VIX chart demonstrates this reason.
Provided by Yahoo! Finance
Each time the VIX peaked, it crashed for an extended period of time. Or, with a different perspective, each time the VIX has been depressed for a long-period of time, it has rapidly peaked. I’ve highlighted the last three peaks and we can see quite clearly how the VIX then made its way down. One point I do note, a VIX in the 11% range is lower than the other lows.
So, what to do if you like buying LEAPS? Vol is elevated to the back months – clearly. But, here’s the trick, LEAPS are elevated relative to the front, but the front is extraordinarily depressed. That means the comparison is to a low number. Check out the two-year chart of BX IV360™, below.
I’ve drawn that red horizontal line from the current IV360™ back in time. We can see just a couple of blips when the long-term implied was below its current value. So… now what?
Well, the back is elevated to the front, that’s for sure. There is contango in the VIX, that’s also for sure. But… for you LEAP buyers (which makes you big time vega buyers), this is one case where “elevated” vol actually still feels depressed.
I’ve included the identical picture below for the VIX for a broader view of the market (but this is only one-year of history; Livevol® does not provide two-years of VIX IV360™.
Same trick here… Yes there is contango in the VIX, but so what?... The long-term implied volatility is essentially at an annual low.
So, final conclusion? If you’re a vega buyer in LEAPS, don’t stop your analysis at the contango effect, there’s more to it. I don’t know if vol will go up or down from here, but for the last one to two years, LEAPS haven’t looked much cheaper than they do now.
This is trade analysis, not a recommendation.
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