There has been a lot of talk on this site and every other financial media outlet about what the low VIX means for the health of the current market rally (see our discussion from Friday here). The truth is no one knows how long this low vol creep higher in the market can continue before we see a meaningful correction and the fact that most of the world will spend the next month watching the World Cup combined with the U.S. long July 4th holiday does not bode well for a spike in volatility any time soon.
That being said, the price action in today’s trading is notable, albeit on light volume without any major themes. The S&P500 opened down on the day, rallied as it usually does after the open, made a new all time high and felt that it may go to 2000 today! Just before noon when the SPX was up 30 bps, the market reversed and now is unchanged on the day:
The fact that I am actually discussing moves this small tells you how starved we are for a little action. Although, what I do think that is worth noting is that sudden reversals off of the highs could likely make bigger waves in terms of volatility as investors who see little need for protection could change their mind on a dime, and a sudden spike in vol could occur in an instant. The 2 day chart below of the VIX shows the 4.5% reversal at noon from the lows of the day to up almost 7%, nearly to the minute that the SPX topped out:
Obviously, the lower the VIX is on a numerical basis, the larger these ticks higher will be on a percentage basis. But the lesson here is relevant for trading in this low vol environment. A down day (or perhaps even two in a row!) is enough to make a huge difference in the vol as far as entries on trade structures. We’ve spoken about our preferred structures in a low vol environment, most recently in Enis’ post earlier today.
What happens to vol in an environment is it can have a snowball effect on long premium holders. Similar to that puke when long stock holders in the midst of a selloff just can’t take it anymore, long premium options work the same way, especially in the front month.
Therefore, it sometimes make sense to sit on your hand and wait for one of those market reversal days that sees the VIX and other implied vol spikes before entering a trade. This applies to both the types of trades we’ve suggested that look to sell near term premium as well as those looking to scoop premium near its IV lows. You’re not going to miss the chance to sell gamma or buy vol in a market like this. If possible, it’s best to wait for those inflection point days.