The up and down nature of the past month has created a rare situation for the volatility markets. The SPX index is now at basically a 3 month high, but realized volatility is also near the highs of the last 3 months.
The following chart shows 3 month realized volatility vs. 3 month implied volatility (so the implied volatility for at-the-money options in SPX that expire in 3 months) over the last 3 years:
In most cases, implied volatility (the black line) is higher than realized volatility, which is an illustration of the insurance-like properties of options, where they are normally priced higher than the future expected move. In the few instances where the market has a big down move (flash crash in 2010 and Aug 2011 down move), realized volatility picks up. Since it’s 3 month backward looking volatility, it usually stays elevated even after the market has calmed down and forward looking implied volatility has started to move back lower.
What’s unique about the current situation is that implied volatility has moved below realized volatility even though implied volatility is already priced near the low end of the last 3 years. It could also just be that realized volatility is relatively high given that the market is only 2% from new highs. That is a rare phenomenon that illustrates how volatile the market has been even as it has pushed higher.
I don’t have any strong takeaways from this other than to think that volatility looks especially cheap here. Interestingly, this situation is even more pronounced in Europe, as Europe is at almost 4 month highs, but realized volatility is the highest it has been in all of 2012.