One Strategist Is Sick To Death Of Hearing You Talk About The VIX

Bloomberg’s Cameron Crise (or “who?” as he’s known to Jeff “The Truth” Gundlach), wishes you would stop complaining about the VIX.

Or, perhaps more accurately, Bloomberg’s Cameron Crise had one last deliverable he needed to submit before the weekend and, at a loss for something else to say, he decided to explain how the VIX works to a bunch of people with Bloomies, which is about like walking into Michelin star kitchen and explaining that romaine is different from iceberg.

So while I’m not sure the note below is all that useful for the target audience, it might nevertheless be useful to some readers and hey, it’s Friday so it’s better not to make people think too hard anyway…

Via Bloomberg

As the VIX index flirts with single digits again, I hear a lot of worrying about complacency in this so-called “fear gauge.” One of the first things that option traders learn is that low implied volatility does not necessarily mean cheap implied volatility. Complacency worrywarts would do well to remember that.

• The VIX is a derivative instrument, as are the option prices that it settles into. Quite literally, this means they derive their value from some underlying asset.
• When there is a notable and foreseeable event risk, traders will pay a premium to hedge. The recent French election is an obvious example of this. In the absence of such an event, however, the price of the insurance that options provide correlates very strongly with the level of perceived risk in the marketplace.
• This in turn is a function of the realized volatility of the equity market. Believe it or not, even at single digits the VIX still represents a 2 vol premium over the 30 day realized volatility of the S&P 500. Where is the incentive to pay more?
• I like to look at the shape of the VIX futures curve as a measure for how much future “fear” the market is pricing into the options market. In fact, it isn’t really “fear” at all, but a classic risk premium observable in plenty of other markets.
• The second VIX future currently trades more than 2.5 vols above the spot VIX. That’s in line with historical norms and actually above the 10-week moving average. As a percentage of historical vol or the VIX itself, it’s actually quite a tasty premium.
• Sure, the VIX is low by historical standards and against a macro model of where it should be. Frankly, I’m sure a lot of option traders would love nothing more than higher levels of volatility.
• But the VIX is low for a reason. Complaining that it doesn’t show the proper level of “fear” is like complaining that you can’t use a corkscrew to change a bicycle tire: it’s trying to use a tool in the wrong way.