Thursday, July 21, 2011

VIX - Vol of Vol Dips as Political Gamesmanship Rises

VIX spot is quoting $17.30, down 9.4% with IV30™ (the vol of vol) down 8.4% as of ~10:45am EST. The Livevol® Pro Summary is included below.


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The CBOE Volatility Index is based on real-time prices of options on the S&P 500 Index, listed on the Chicago Board Options Exchange (Symbol: SPX), and is designed to reflect investors' consensus view of future (30-day) expected stock market volatility.

There’s an impending decision (or failed decision) to be made relatively soon on the debt limit and overall budget for the United States. All three ratings agencies have published warnings that a default would catapult the US debt well below the top AAA (Aaa) status and could even push the rating into junk for a moment. There are whispers that even if the US is able to avoid default (which is likely), that unless there’s a follow up plan (other than raising the debt limit) that impresses, the US rating could go to one notch below AAA (Aaa) and thus make the apotheosis of risk-free assets (the US t-bill) lose that title.

Let’s take a look at the Charts Tab for the VIX (6 months). The top portion is the index spot, the bottom is the vol (IV30™ - red vs HV20 - blue vs HV180 - pink).

With the “decision” impending, it surprises me a bit that the IV30™ is dipping and is now well below the historical vols. Specifically:

IV30™: 72.64
HV20: 100.22
HV180: 103.95

That, in and of itself, makes a vol trade worth examining. Let’s turn to the Skew Tab.

We can see the opposite of “normal” skew, but, that’s actually “normal.” The upside in the VIX is the fear, so vol increases to the OTM calls and decreases to the OTM puts. In English, the upside in the VIX is used as a hedge for a down market and therefore the demand is higher for those options (calls) than the downside puts, thus raising the price (vol).

The question surrounding the decision is a delicate one – as it’s political more than anything else. How far do Congressional Republicans want to push a compromise? Is a default better for the GOP enough to offset a potential market decline? For the Democrats (and the President), what compromises simply can’t be made? It’s not the US finances that are the top question, it’s political lives – and that could mean volatility.

Let’s turn to the Options Tab for completeness.

I wrote about this one for (OptionsProfits), so no specific trade analysis here. But, either way you look at it, this is a speculative play on a speculative decision on a relatively complex asset.

Full Disclosure: I hold a small position in VIX Aug options.

This is trade analysis, not a recommendation.

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