Monday, February 3, 2014

VIX - Doomsday Scenarios Revisited; It's the Volatility of VIX That's Our Signal, Not the VIX.

VIX spot is quoting $20.98, up 14.0% with IV30™ up 14.7%. The Symbol Summary is included below.

Provided by Livevol

This is a follow up to a five-part series I wrote on the VIX and doomsday scenarios. You can read the final post in that series by clicking on the title below:

VIX - Part 5: Doomsday/Bubble Scenarios: Its the Volatility of the VIX that's Our Signal; Not the VIX Itself

The bottom line from that series was simple:
1. I see a market malaise in the options, and that is worth watching very closely.

2. Here's the thing, and there's just no way around it, while the option market has been pricing in low forward looking 30-day volatility in VIX, the option market has been dead wrong.

3. The VXI articles surrounded the idea of whether or not (or how) VIX could be used as signal to the potential doomsday scenarios. The main conclusion I came to (which is my opinion) is that it’s not the VIX that is our signal, but rather than implied volatility of the VIX. I still feel the same way. Those articles and that time frame proved the hypothesis to be correct (for that time frame).

Back then the volatilities by expiry for VIX were:

Feb'14: 58.40%
Apr'14: 54.84%

And I said:
How confident are you that the market will not only stay at this level of risk, but will reduce substantially all the way though April 2014? The option market reflects a great deal of comfort; a new equilibrium, a relaxed and quiet equilibrium. Is there an event in the near future (before April 2014) that may be evidence to the contrary? If you said no... think harder...

Today the volatility of the VIX has breached a multi-year high, and that may signal a turning point in the market. The Charts Tab (two-years) is below. The top portion is the spot price, the bottom is the vol (IV30™ - red vs HV20™ - blue vs HV180™ - pink).

Provided by Livevol

So, we can see on the top portion how the VIX has popped of late.  Honestly, the option market has just been dead wrong on the risk in the market.

But, this is a volatility note, so let's turn to the IV30™ chart in isolation, below.

Provided by Livevol

Here's where it gets interesting.  The last high in the volatility of the VIX was hit during the government shutdown.  And we were on the precipice of a correction until Washington "worked it out."  I believed that the 115% volatility level for VIX  seemed to be a sort threshold -- cross it for more than a day, and we're in for a move down.  That level was touched as the market was dipping, but on the worst day of the market, the volatility in the VIX actually dropped (even as VIX rose). It was that phenomenon that lead me to believe all was OK, and the market was essentially done with its correction.

Now let's turn to today.  We can see that multi-year high in VIX implied volatility.  If that level doesn't hold even if the market goes down and VIX goes up, then I think we may be through this rough patch.  But... if tomorrow the VIX is up and the volatility of the VIX is up... This could get worse.

And what about those prior levels of volatility we saw in Feb'14 and Apr '14 risk that I said were way too low.  Check this out:

Provided by Livevol

Across the top we can see that Feb vol is now priced to 133.08% (up from 58.40%) and Apr vol is now priced to 85.33% (up from 54.84%).  Yeah, the option market was dead wrong, has been dead wrong and now we will see if it can be our signal for the future.

The world is not ending. We are not in a Doomsday Scenario. But we could be soon.  

This is trade analysis, not a recommendation.

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  1. i think you are saying we could have bought options when they were way underpriced, then sold them when the market woke up to the risk and the price of options jumped, and made a nice profit.

    we can use the Implied Volatility of the VIX compared to the price of options as an indicator to judge if options are priced too low, and make a decision to get in.

  2. i dont really understand, but i keep reading