The state of S&P 500 volatility

The following charts give us a good look at the current state of equity market options and volatility. Whenever there is a turn lower in the market, people rush to look at what is happening in the cash VIX index. Watching VIX alone is too limiting. We are looking also at medium- and longer-term options and at the realized volatility of implied volatility.

Fig. 1. CBOE Volatility Index. Source: CBOE, Condor Options

First, the momentum of VIX has turned decisively higher. The index was below 15 for much of September, but has reverted now toward its longer term mean. Two short-term moving averages are also trending higher now, and we are advising clients to avoid adding new long equity and short volatility positions, and to start reducing existing positions while implied volatility is trending higher.

Fig. 2. SPX VIX-style Term Structure for 2012-11-09. Source: CBOE, Condor Options

Second, the term structure of SPX option implied volatility (IV) is normal – it is mostly in contango. It’s true that November IV is higher than December, but November SPX options expire in a few days and the short term IV was not backwardated just a couple sessions ago. Until December trades above January, we will regard the option values as ordinary.

We can also use the same chart to quantify the term structure and identify significant changes in market sentiment. The ratio of one year and one month IV levels is about 1.27, indicating that longer dated options are priced significantly higher – generally a sign of a normal and healthy market.

Fig. 3. 1-Year / 1-Month VIX Ratio. Source: CBOE, Condor Options

However, the time series of this ratio shows that the richness of long-dated options has been declining steadily since late August. That is, the slope of SPX IV term structure – looking just at two points, rather than the whole curve – has been flattening pretty steadily for many weeks. The lower this ratio goes, the more reason investors have to exit long stock positions and/or increase the size of portfolio hedges.

Fig. 4. VIX 10-Day Standard Deviation, 2012. Source: CBOE, Condor Options

Finally, we are looking at the 10-day standard deviation of VIX closing values, or the historical volatility of one-month SPX IV. The horizontal bars show the top quintile thresholds for this time series over the last year and the last quarter. If this estimate rises above those thresholds, it serves as another indication that markets are becoming stressed and portfolio exposure should be reduced. As you can see, this estimate nearly gave a signal to start exiting the market in early November, but has now moderated below 1.0.

We review these indicators of market stress regularly in our trade notices and market commentary for clients.

4 Comments For This Post

  1. Dave Says:

    Great post! What symbol is usedto determine the 1Y VIX value? Used in the ratio of the second chart.

  2. Jared Woodard Says:

    Thanks, Dave. The one-year VIX values are calculated from CBOE data – there’s no symbol or published index for that horizon.

  3. Charlie L. Says:

    a) A 1Y/1M of 1.27 has a different interpretation when 1M is at 14 as opposed to 25 or 30 for example. To what extent should the 1Y/1M VIX ratio (figure 3) be adjusted for the absolute value of the front month? Or maybe adjusting for the 1M actual over realized value.
    b) Would the IV of front-month VIX ATM options be more appropriate given it’s forward looking as opposed to the 10-day StDev of VIX closing values (figure 4) given they are backward looking?
    Thanks, love your work!

  4. Jared Woodard Says:

    Thanks, Charlie.

    a) I’m not sure that the interpretation is so different with 1M at 25, but I suppose we would multiply each point by its historical beta complement to get a more normalized curve.

    b) It’s a good question, whether something like VVIX would give a better signal than VIX stdev. My suspicion is that traders would smooth IV changes in the short term such that stdev swings would be cleaner, but it should be straightforward to answer this empirically.

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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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