VIX spot is approaching the 10 level, which it has only touched on a few occasions over the past 10 years (and really, since the inception of the index):
The main difference between the 2004 to 2007 low volatility period and the 2012 to 2014 low volatility period is that the total move in the S&P 500 index over that period has been much greater during the 2012-2014 time frame, moving 700 points higher (from around 1250 in June 2012), vs. around 400 points higher from June 2004 to June 2007.
We’ve noted this difference before, where volatility on a longer-term time frame is higher in the current market than the low level of daily volatility indicated by the VIX and daily realized volatility in the SPX index.
Yesterday, there was a large buyer of VIX call options, which I mentioned in this morning’s TMO post:
1. VIX – Huge four way trade. Trader bought 144k of the July 13/16 risk reversals, paying .19 to sell July 13 put and buy July 16 call. Same trader sold 288k of the July 20 calls at 0.27, and bought 144k of the Sept 20 calls for .94. This trade looks like a hedge, where the trader wants to have 288k contracts worth of VIX calls, though the July strike was moved lower (and the trader took on the risk of July VIX below 13), and part of the hedge was moved out to September. VIX spot is on track for its 5th straight monthly decline (though still a long way to go in June), which would be only the 3rd time that has happened in the past 10 years (the other two instances are mid-2009 and early 2012, both coming off of big VIX spikes).
That trade was a significant amount of additional premium in VIX calls. The roll comes at a time when even back-month VIX futures have moved down to the mid-teens, as can be seen by the VIX futures snapshot:
The 6 month and farther maturity VIX futures have generally been in high teens or above 20 in the past couple years, even when VIX spot got below 13. However, the current move indicates that traders are finally more comfortable that volatility will remain low for some time to come.
Another reflection of the lack of bid for volatility products is in VXX. We have mentioned many times that we view this as a broken product, but it’s noteworthy that even the poorly constructed VXX is at its most oversold over the past 5 years, with a daily RSI(14) reading of 12 (bottom panel), well below the prior oversold readings of around 20:
One final note – at this juncture, I think implied volatility needs to rise before any meaningful selloff occurs in the major indices. What do I mean? Since options protection is currently so cheap, equity owners have little incentive to sell their stock holdings when they can just buy cheap protection. As long as that is the case, I would be surprised to see a large move lower in the U.S. markets. In other words, only after implied volatility rises and options are priced more expensively will stockholders have an increased incentive to reduce their long stock inventories.
We’ve seen this phenomenon before where a breakout in the SPX to the upside coincides with a rising VIX. We’ll be keeping our eye on it this time around.