CNBC: Friday Close
Spot Vix fell a full eight percent on Friday, as hopes in a China trade deal sparked higher prices. Whether such hopes are justified will be revealed in short order. No doubt the recovery adds pressure to both sides to follow through with a reasonable negotiation process.
Thoughts On Volatility
Quite a rally that we've witnessed! Spot VIX was up around 36 at that time, and now is seeking new and lower ground in the low-to-mid teens just two months later.
Many take the view that vol gets crushed when equity prices rise. I think that can be true, but it can also be just as true that stocks rise because volatility is falling. After all, if volatility is a way of gauging risk, then lower vol should in fact justify higher price tags on stocks.
If that is so, the greater question may be whether last quarter's madness was some kind of grand spoof or panic attack. Who is to say that the volatility could resurface on short notice? Incidentally, vol did calm considerably between mid-May and late-September of last year, and then returned with a vengeance. How likely is a redo?
Much of the earnings outlooks are less than sanguine for US companies. Depending on which multiple measures you use, index valuations range from reasonable (e.g. 12-month forward operating) to egregious (e.g. price-sales).
If stocks are priced for moderate outcomes, then the dimming outlook for earnings is not so problematic. If on the other hand the market deems that stocks are quite pricey, then a difficult period may be in the offing.
This is frequently a misunderstood idea as it relates to vol: that when implied volatility is high, it is accounting for extreme bad and good scenarios to play out. Pure vol is just pricing in the breadth of different possibilities in percentage terms.
While 18% is indeed impressive, we should use the occasion to appreciate that the vol markets got it right on December 24th.
First, let's agree that what we've witnessed in US stocks is, by any measure, a recovery, not a "recovery", with quotes. The demolition of those grizzly three weeks in December has been almost entirely unwound in both the stock and volatility markets.
As evidence, look at how the 30HV is now only a few points above the HV10. This requires a rather consistent pattern of markets saying yesterday's price was at least close to right.
As Volatility Trading mentioned in the Tweet above, contango is low, as VX doesn't want to adjust suddenly to new developments (as we'll see confirmed in the visual below). Recall that it is roll yield between the M1 and spot that is the real cause of decay for vol longs (when spot is below M1 - VXXB, UVXY, TVIX) or vol shorts (when spot is above M1 - SVXY, ZIV). By this measure, the decay to longs is considerably greater than what the M1-M2 contango presently indicates.
The VIX of VIX, which has spent the entirety of the last month below 100 (and the majority of that time below 90), still speaks to a rather rigid forward-looking front end of the VX futures curve. This indicates to me that there is still room for a drifting VX rather than a violently jerking set of outcomes.
Remember that even vol of vol is itself a symmetric concept: it predicts stability, not direction.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I actively trade the futures and options markets, potentially taking multiple positions on any given day, both long and short. I also hold a more traditional portfolio of stocks and bonds that I do not "trade". I do believe the S&P 500 is priced for poor forward-looking returns over a long timeframe, and so my trading activity centers around a negative delta for hedging purposes.