Is This Volatile Enough for You?

I’ve heard some infuriating takes about how the high level of VIX and inverted curve in its futures indicate a sign of potential capitulation.  When we consider that “the VIX Index measures the 30-day expected volatility of the S&P 500 Index”, and then take into account that the coming 30 days include earnings season and a midterm election, it is sensible that VIX would see elevated values in the short-term.

While past is not always prologue, we are evidently in a period of high volatility.  Let’s recap the past three days in the S&P 500 Index (SPX), shall we.  Up 2.6% after recovering from a similar-sized intraday drop, down 2.4%, then up by 2.2% (as I write this).   Nothing to see here, correct?  Especially when two of the three sessions were big up days, aka “socially acceptable volatility”, right.  In the sessions prior to today in the month of October, we’ve seen 6 of 10 close with moves over 2%.  And let’s not forget the abundance of moves of 1.5% or more since September 1^st, as shown in the graph below:

SPX, Daily Bars Since September 1st

Source: Interactive Brokers

If we bear in mind that VIX and other common measures of volatility are displayed in annualized terms, we can use the “rule of 16” to convert them into daily terms.  A volatility of 32 implies a set of daily moves of 2%.  While the VIX methodology incorporates all call and put options with non-zero bids and times to expiration between 23 and 37 days, making it directly comparable with at-money SPX options, it is broadly consistent with at-money volatility assumptions and highly consistent over time.

The VIX futures curve also allows us to see whether expectations for future volatility are rising or falling.  A glance at the current term structure show that traders have ratcheted up their volatility assumptions over the past month, though reduced them somewhat over the last week:

VIX Futures Term Structure, Today (October 17^th, yellow), 1 Week Ago (red), and 1 Month Ago (purple), with 1-week (red) and 1-month (purple) Changes in Lower Panel

Source: Interactive Brokers

Some of the reduction in expectations since last week can be explained by the fact that we are no longer looking ahead to CPI and PPI numbers – they’re now behind us, with accompanying volatility.  But it is reasonable to expect that some residual volatility can ensue over the coming weeks, and for volatility to decline once the midterm election is firmly in the rearview mirror.  It is the latter event that should keep volatility expectations elevated in the near-term relative to the subsequent weeks and months. Just less than a month ago we asserted that the then-current 29 level of VIX seemed about right.  I’ll make a similar assertion now, though it is highly subject to monetary and fiscal policy events, corporate earnings and the Congressional election.  Come to think of it, that’s quite a litany of potential events.  But as long as we remember what VIX is measuring – and it’s not fear – we can keep the current readings in the proper perspective.