VIX Is Up, But Why Not Higher?

By Chris McKhann

The VIX has popped back above 30 again and is now trading above the July futures.

The VIX is currently up 9.27 percent to 30.54, after gapping up to 30.32 at the open. This puts the spot value above the July futures which trade at 29.50. The August futures are up 0.65 percent to 30.85, while September is up 1.45 percent to 31.55, and now carries the largest premium over the spot VIX.

Many casual observers continue to question why the VIX isn't higher, but we stress that the volatility index must be looked at in relative terms. And the most important relationship is the VIX to historical volatility, which for the last 20 days is below 21 percent. This means that the VIX is very high.

As a Bloomberg article has also pointed out, the volatility skew is also at its highest level. The measure used compares a 10 percent out-of-the-money call to a 10 percent out-of-the-money put.

This means that, in relative terms, those puts are at their most expensive since before the Lehman collapse last September. But it does not mean, as the Bloomberg article states, that "traders pay more for bearish contracts than any time since before the failure of Lehman Brothers Holdings" or that "investors are spending the most since August 2008 to protect against a 10 percent decline in the Standard & Poor's 500 Index versus wagers on an advance."

The VIX at 80, as it was back in September and October, means that the implied volatility of the SPX options is 80 percent, and at that time a 10 percent out-of-the-money put cost far more than it does now. Right now a 10 percent out-of-the-money put for July is $1.75 and for August is $11.10, with implied volatilities of 39 percent and 33 percent respectively.

If we increase that implied volatility to 90 percent using an options calculator for July, the cost is $19.70. For August, using 80 percent implied volatility, the cost would have been $59.

Clearly there is a huge difference. The skew is very different from how much one is paying or spending for their options.

(Chart courtesy of tradeMONSTER)