By Taras Berezowsky
Commodity price volatility – and how to manage that volatility, especially in metals markets – has been on our brains lately. Heck, who are we kidding … it’s always on our brains.
But one tool in the commodity price risk manager’s toolbox, the VIX index (the Chicago Board of Exchange’s tool for measuring implied volatility), looks as though it’s under pressure for not performing as accurately as it could lately, according to an FT article.
VIX Getting Revamped
A company called NationsShares, also based here in Chicago, according to the FT, is putting some heat on the CBOE’s Vix by creating a new – and, the company claims, more up-to-date – index to measure volatility, called VolDex.
“NationsShares says its VolDex measure uses options on the SPDR S&P 500, an exchange traded fund (ETF) that seeks to replicate the performance of the overall S&P 500. Options on the “SPY”, as the ETF is known, are the ‘most liquid options in the world,’ according to NationsShares,” the article states.
How the VIX stacks up against VolDex and SPY. Source: NationsShares via ise.com
Basically, VIX futures, which are traded off the VIX index itself, have risen drastically in recent years due to their foundation for exchange-traded products (ETPs), and that in turn makes the price of VIX futures stray far from the actual index.
Make sense? A little convoluted? Here’s a bit more background.
How the VIX Volatility Index Works
The VIX, more fully known as the Chicago Board Options Exchange Market Volatility Index, is a “a weighted blend of prices for a range of options on the S&P 500 index,” which “represents one measure of the market’s expectation of stock market volatility over the next 30 day period.”
As the FT explains, “for instance, when the Vix is low, 30-day options are cheap, suggesting there is little demand for protection.” (Interestingly, the VIX and aluminum demand have historically moved together.)
Why New Fear Index Matters
Although the new upstart index is less all-encompassing, it may serve as a more accurate indicator.
“Unlike the Vix, the VolDex also focuses on a smaller pool of options by stripping out “out-of-the-money options” that have veered away from market prices,” the FT says.
Ahh, getting a little closer to the meat of the nut. We like that.
This points to what’s especially important in metals markets, where speculation, derivative activity, cash-and-carry schemes and the like have played a role in distorting supply/demand fundamentals – and prices.
“I would be shocked if traders decided to start using VolDex in lieu of the Vix,” Jason Goepfert at Sundial Capital Research told the FT. “It’s a flawed index, not necessarily representative of the market, but it has become ‘institutionalised’.”
By that logic, metal buyers should continue to use outdated BLS data in their metal buying strategies, but would that serve them best, based on current trends of price volatility in steel, stainless, and copper markets, for example?
We’ve taken the approach that NationsShares is now taking, and that is to provide a more accurate look at the metals markets based on underlying data. Check out our Monthly MMI Report, based on 10 weighted sub-indexes tracking industrial metals markets, and test for yourself.