Macro Wrap – May and June Have Likely Marked the Turning Point in Volatility, $VIX

by Enis June 18, 2013 7:29 am • Commentary

Yesterday, we received a great question in our “Submit Your Question” section of the site:

Today market up more than a percent but VIX is also trading days High..shaking off initial loss? Something has to give in, right? Your thoughts ?

This was my response:

I think there are two main factors providing a bid to VIX (and implied volatility in general). First, the FOMC event on Wednesday has a lot of traders positioning for a large potential move due to the event, so the VIX is likely to remain somewhat elevated until that event. Second, realized volatility in the SPX index has picked up in the last couple weeks. 10 day realized volatility is up to 17.50, near the highs of the past 6 months, and we’ve seen a greater than 1% move in either direction in the index on 5 of the last 10 trading days.

In that sense, I still prefer long VIX positions to short SPY positions as a hedge. We might get involved in July VIX if the futures get to the 16 area.

It’s the second point I wanted to highlight this morning – the increase in realized volatility.

Bespoke had a wonderful chart illustration yesterday afternoon along those lines:

Below is a look at the longest streaks of 100+ point days for the Dow in its history.  Obviously since we’re looking at point changes instead of percentage changes, the streaks didn’t begin until the late 90s once the Dow moved up above 5,000.  If we do manage to close up 100 points (or down 100 points!), it will be the 14th time the Dow has gone 5 consecutive trading days with 100+ point moves.

Screen Shot 2013-06-18 at 7.10.34 AM

The recent streak is the longest since 2011, which was a much more volatile year than 2012 or 2013.  What caught my eye was that there were no streaks of more than 4 days for the entire bull market between 2003 and 2007.  The VIX was below 12 this year for the first time since that bull market, but I don’t think current market structure is nearly as stable as it was then.  That’s a short way of saying that I think the VIX is a a good risk/reward buy whenever it gets below 14.

Granted, streaks alone are more factoid fodder than quantitative evidence, but realized volatility in the SPX has also started to pick up.  Here is the 2 year chart of 10 day realized volatility in the SPX:

2 year chart of 10 day realized volatility in SPX, Courtesy of Bloomberg
2 year chart of 10 day realized volatility in SPX, with red line at 20, Courtesy of Bloomberg

This measure has hardly been above 20 (red line) in 2012 and 2013, after the severe volatility in the second half of 2011.  It is still below that level today.  The VIX, though, has remained between 15 and 20 for all of June, in contrast to its behavior for much of this year.

I still view increased volatility in stocks as the more likely scenario (rather than reduced volatility) in the second half of 2013, mainly based on how other assets have moved in the past few months.  Currency and commodity volatility have picked up considerably, and bond volatility in the past month is at 1 year highs.

This is a different environment than the gradual, grinding rally we saw to start the year.  As has been the case for the past few years, May and June have likely marked the turning point in volatility.

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