The European Volatility Risk Premium Persists

The media narrative at the moment is that U.S. investors are happy to ignore all things European for as long as modestly positive domestic economic news keeps trickling out. The headlines today about stocks being up “on” news from Alcoa were silly enough,* but this does seem to be a real theme – slight reductions in the odds of a 2012 recession mean it’s time to pile into stocks, apparently.

The smarter parts of the market qua options and volatility traders have a differnent idea. Note the divergence in February VIX futures and February VSTOXX futures (the VIX-style equivalent for the EURO STOXX 50 index).

Source: Interactive Brokers

That’s nearly a four-point premium and it is pretty unusual. It means that traders have higher credences in the likely future volatility of European equities than they do for S&P 500 constituents. The same sort of premium is present in options on the euro currency: implied volatility continues to run higher than recent historical volatility in the currency futures, and we added more short gamma exposure to the currency today for clients and in the condors newsletter. Now, as markets have quieted down considerably, it is true in just about every asset that option implied vol is higher than recent price action would suggest; what’s important is that the volatility risk premium in European equities and the euro is higher than it is everywhere else.

* Silly because 1) associating random and complex intraday stock price movement with specific events is nearly impossible; and 2) because the preposition “on” isn’t fooling anybody, market journalists! We all know that by “on,” “as,” “while” and etc. what you really mean is Because.

Disclosure: positions in VIX, VSTOXX, EUR/USD, FXE, SPX, and SPY futures, shares, and options.

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1 Comments For This Post

  1. pat Says:

    Technical analysis on the VIX seems to me to be to be a total waste of time. The idea behind technical anylasis is to look at the past to get a hint of the future and the VIX is a measure of emotions (current).
    Pat

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Jared Woodard specializes in trading volatility as an asset class. With over a decade of experience trading options and other volatility products ... Read More

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