MorningWord 5/22/15: $VIX – Do You Realize??

by Dan May 22, 2015 9:35 am • Commentary

In Case You Missed It, the S&P 500 (SPX) made new all time highs yesterday.  Per Bloomberg, 275 stocks in the SPX advanced, while 222 declined, while only 4% are at new 52 week highs, but 65% of the index is trading above its 50 day moving average.  To state the obvious, upward momentum has been building, albeit slowly, and almost begrudgingly.

One thing is certain, owning options premium to play for a breakout to new highs has been a painful experience, with ten day realized vol (how much the index has been moving, in white below) once again reaching mid single digits, implying less than 1% movement, which has made options prices (realized vol in blue below) expensive, despite trading new 52 week lows:

SPX 10 day realized vol (white ) vs 30 day at the money implied vol (blue) from Bloomberg
SPX 10 day realized vol (white ) vs 30 day at the money implied vol (blue) from Bloomberg

On the flip-side, one supposed piece of options trading wisdom has been to buy protection when you can, not when you need to.  Meaning buy it when its cheap, not when it gets bid after a move lower in direction, and up in vol terms.  If this bull market has shown us anything that the opposite has actually been true, owners of risk assets looking to frequently buy protection in the form of put premium have seen their returns routinely eroded as declines have been short and sweet.  Could this pattern be coming to an end as we get closer to the FOMC raising interest rates?  It feels that way as rate have risen of late and almost every other major risk asset in the world has seem some fairly real volatility, commodities, currencies and of course bonds, while the largest equity market on the planet grinds higher with a sort of complacency that has flecks of reckless abandon.

We are not believers of buying options premium just because it is cheap, the math actually speaks to the opposite.