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Implied volatility continues to sell off, with VIX down 10% (of vol, not points) month to date. The sell-off is particularly strong for short-dated options as VIX futures curve continues to steepen. The chart below shows VIX futures one-day move along the curve, with the nearby contract coming off sharply.

(Bloomberg)


(Click to enlarge)

With bullish year-end calls, we continue to have a case of "cognitive dissonance" as risk indicators diverge. Surprisingly this time we are seeing the decoupling of the USD swap spreads and the US implied volatility index. The two-year USD swap spread is up 4 bp today, while VIX is down some 3%. This indicates further decoupling of short term risks in equities from medium term bank funding risks.

(Bloomberg)


(Click to enlarge)

Given that funding risk is generally associated with banks, this divergence is also visible in the underperformance of the financial sector during the past week. The chart below compares recent performance of XLF and SPY ETFs (financial sector vs. the overall market).


(Click to enlarge)

The broad interpretation here would be that Europe's problems may impact U.S. financials, but in the short-term the U.S. equity market risks have diminished. Again, if one disagrees with this fundamental view, this may be a good opportunity to put on a trade: for example long SPY puts, receive fixed on the 2-year USD swap, and short 2-year Treasuries.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: The Steepening Volatility Curve And More Risk Decoupling