Market Volatility Bulletin: VIX Pops Nearly 6% On Small Drop In S&P

by: The Balance of Trade

US indexes are down some today, and spot VIX takes notice.

The volatility premium is not a static quantity that one can simply adopt to earn high levels of alpha: markets learn and adapt.

HV10 is now down at a staggering 6 handle!  Long-vol positions are enjoying gains for today, and I share thoughts on when UVXY should be used vs. VXXB.

Market Intro


I don't know if a 55-basis point drop in the Dow (DIA) constitutes "Breaking News"... but there you have it. The S&P 500 (SPY) is also down about half a percent, while the higher-beta NASDAQ (QQQ) and Russell 2K (IWM) have shed closer to a percent as we head into Wednesday's afternoon session.

Spot VIX is up almost 6% in a fairly ho-hum down day for stocks.

Thoughts on Volatility

The real problem with experimental monetary policy is that there doesn't seem to be much of a record as to exit strategies. When combined with unintended solutions (e.g. high levels of corporate debt, not to mention government debt), this has the potential to be terribly problematic at some point in the not-too-distant future.

If monetary policy makers want to explore solutions to crises such as QE, then they need to be willing to deal with the fact that there will likely be some kind of fallout or consequence in the future. Whether that is added market volatility, or a wave of higher defaults in the future as corporations lever up, or some other unforeseeable consequence, then so be it. It appears to me that central banks are looking for that sweet path to exit where nobody even notices that they are winding down their balance sheets. Not gonna happen.

Awesome Tweet, Mr. Hennessy. Markets change, as participants respond to opportunities (real or perceived).

We're not even a quarter through 2019, and the Q1 environment for the S&P 500 has been rather unique. So it's too early to read into this.

I read this visual as saying that so far in 2019, realized vol has been higher than the VIX. That puzzles me greatly, as realized vol has absolutely collapsed this year. I do wonder if the construction of the metric leads to a counterintuitive conclusion. Any insight on this from readers would be appreciated.

Most importantly though, I firmly believe that market practitioners do not simply allow high-alpha opportunities to persist. It would make sense as volatility markets develop that a volatility risk premium would decline.

Term Structure

In keeping with why the Tweet above from Mr. Hennessy confuses me, look at the following gap between spot VIX (green) and HV10 (yellow). I see a very wide vol risk premium for this particular pair (HV20 is more typical as a pair, and that premium is currently 7.14 points).

If spot VIX pops almost 6% on a .5% drop in the S&P 500, it will be difficult to drop the VX term structure much lower from here. I write that in context of what happened in 2018. We saw plenty of examples of spot VIX launching off a very low base in 2016-2017, and VX futures were substantively lower during that period than they are today. But that was because, quite rightly, there was a "We'll believe it when we see it." quality to the market's perception of near-term volatility.

But now the market has seen it. And as such, even a modest drop in stocks can make VX traders wary of selling the front months too vigorously.

The long-vol position (VXXB, UVXY) is enjoying a nice boost in Wedensday's session after a fairly uneventful beginning to the week for stocks.

Note that VXXB has lost about a third of its value in relation to where it stood at the inception of the quarter. There are plenty of traders waiting for a rebound in vol here, even if it's just a temporary pullback. The NFP report, as well as Chair Powell speaking on Friday, could act as catalysts for such a move. Really though, while markets are sometimes suck punched, they mostly retreat or surge simply because they feel inclined to do so; it's the nature of the beast in developed secondary markets.

Dollar for dollar, UVXY is the better instrument for those looking for a meaningful and consistent run-up in VX M1 and M2 levels, which in practice corresponds to higher levels of realized SPX volatility. So for a punctuated spike, that's the better play. if you believe that vol will move higher, but in a more gradual, two steps forward one step back fashion, then VXXB is the preferred instrument (again, dollar for dollar).

Wrap Up

If this is your first time reading Market Volatility Bulletin, thanks for giving it a try. If you're a regular, I thank you for your ongoing contributions in the comments section.

Thank you for reading.

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.