Well, no one can say there’s been a shortage of coverage when it comes to suppressed vol.
Indeed, the extent to which this market is “volatility-less” has grabbed quite a few headlines as everyone attempts to solve a mystery that may be no mystery at all. That is, low realized vol begets low implied vol and the Trump trade telegraphed clear winners and losers leading directly to plunging stock and sector correlations so you know… what’s with the whole “mystery” meme?
Anyway, this is one of those topics that you kind of have to mention every once and a while because people like it – and we aim to please.
When last we checked in on volatility we made a request of readers. To wit:
Specifically, we noted the following from Goldman:
Lowest Q1 VIX level on record
- Despite a quarter characterized by elevated policy uncertainty and an intense focus on tax reform, infrastructure spending and deregulation, U.S. equities had one of their lowest volatility quarters on record.
- The average VIX level in Q1 was 11.69, the lowest first quarter in VIX history. Low volatility levels were persistent, with the VIX trading in a tight band between 10.6 and 13.1 over the first quarter.
- If we include all calendar quarters, Q1 2017 was the second lowest quarterly average VIX level back to 1990; only ranking behind Q4 2006, when VIX averaged 11.03.
Well, given the fact that it looks like conveniently-timed VIX crushes are set to play an increasingly important role in supporting this market now that the USDJPY ignition mechanism and 10Y yields are at least temporarily (and perhaps permanently) sidelined, we thought readers might like a little nuance with their vol analysis. Read below as Deutsche Bank takes a granular look at “hibernating” volatility.
Via Deutsche Bank
Winter Ends But Vol Stays in Hibernation: Add to Hedges Selectively
Low vol persists despite seemingly risky environment. It’s hard to call for a quick return to higher vol, but we continue to watch for signs of life for vol (most recent: wider intraday trading ranges than would be consistent with the low level of close-to-close vol). In a sense little has changed in the last few weeks – but the passing of yet more weeks of this low vol environment is noteworthy in itself. Dec-Mar was just the second time the past 40+ years the SPX has had sub-8% RV for four consecutive months, and this relentless low vol has started to put pressure on measures of long-dated implied vol.
Catalysts continue: after the Fed rate hike and the failure to pass new healthcare legislation did not push vol out of its range in March, April’s French elections and looming US budget deadline could draw some hedging interest, and at a minimum should put a floor under short-dated implied vol covering late April. The breakdown in healthcare legislation makes us wonder if more congressional hurdles are to come. Fiscal spending challenges could put pressure on long-dated interest rates, yet despite interest rates testing the bottom of their post-election range, rates vol has been falling quickly.
Vol picked up in March – so why does it feel so low? March contained the SPX’s first 1% selloff of the year and saw the highest SPX realized vol since November. However, vol feels like it’s still falling, and for a good reason: as time passes since we’ve had a truly volatile period, longerdated metrics of realized vol continue to come down, and with them longer-dated implied vol measures are falling as well. This creates an opening for long-dated vol buyers to add to positions. Short-dated IV is actually rich compared with very low realized vol; TLT options look like better value from that perspective. Vol-of-vol has been low as well: in addition to vol being low, it has been range-bound. the VIX is not moving around in the same way it did during similar recent low-vol periods and instead is remaining in a tight 11-13 range for months.
SPX Volatility: SPX off to a low-vol start; hard to call for an immediate reversal despite ongoing catalysts
Lowest vol Q1 since 1965. There are many stats we can point to about how low volatility has been year-to-date, and most tell the same story: we’re again approaching some of the pre-financial crisis lows in implied and realized vol. What has changed the most recently is that the duration of this low-vol period has extended – making longer-term RV metrics and high half-life exponentially weighted metrics continue to fall. These falling metrics may be contributing to the significant weakness in long-dated vol.
Close-to-close vol dampened by late-day reversals. One of the reasons typical realized vol metrics look as low as they do recently is some intraday mean reversion that turned some volatile trading days into near-zero close-to-close moves. The 1.5% median SPX trading range (high minus low as a % of spot) seen in the last two weeks is the highest seen since the period around US elections. This is one sign of life for SPX vol, but despite ongoing catalysts it’s hard to call for a quick change in this volatility environment given how entrenched the quiet market has become.
Heightened interest in 28-Apr expiry. The convergence of the first round of French elections and the US congress’s budget deadline have driven interest in the 28-April weekly expiry. That said, with 28-Apr implied vol sub-10, it’s reasonable value. Given last year’s vote surprises, it’s hard to see markets fully writing off a surprise in France, so we think 28-Apr options have limited vega-downside.
VIX Markets: Extremely low realized vol-of-vol facilitates short VIX option strategies
Some of the least volatile VIX months on record. The three monthly VIX futures that have expired this year have each been among the past 10Y’s ten least volatile, creating a pattern of very low realized vol-of-vol. With VIX option prices low but not breaking down, this trend has left VIX and VXX options very expensive relative to realized vol.
VIX option vol term structure yet to normalize. Typically, VIX option maturities have ATM IV levels that are ordered by maturity: the shortest-dated options have the highest IV (since longer-dated VIX futures are slow-moving). However, that typical relationship has eroded over the past month as exceptionally low realized vol of VIX futures has put pressure on short-dated IV and longer-dated IV has been boosted by upcoming catalysts. Falling April and May IV levels may indicate that markets see French elections as less Brexit-like than they did a few weeks ago.