“This Efficiency Is Surreal”: Low Vol. Is The “Story Of The Year”

Why is vol so goddamn low?

That’s the question everyone is asking.

Assuming it makes sense to use “perpetual” and “du jour” in the same sentence (which it may not), volatility has become the market’s perpetual topic du jour. 

And as with most quandaries that morph into veritable fixations (or, “VIX-ations” in this case), no one will ever be satisfied that the mystery has been solved or that the question has been satisfactorily answered.

These kinds of obsessions tend to persist in perpetuity, which means that even if we do get back to some semblance of normalcy in terms of volatility, everyone will still be asking the same question only retrospectively.

That quest to answer what we’re all determined to make unanswerable will take on an extra sense of urgency if, as some commentators suggest, the low vol regime ends up catalyzing a cascading series of unwinds when the spell finally lifts and vol spikes.

It was just Friday evening when we revisited this subject, but on Saturday we got the latest from Deutsche Bank’s Rocky Fishman and because he covers this extensively, we wanted to present some excerpts here for those whose weekend “VIX-ation” still needs sating.

Via Deutsche Bank

Lowest-vol start to a year since the 1960’s driven by strong spot markets, low intra-SPX correlation, lack of surprises

Low vol: the equity derivatives story of the year. With all of the uncertainty expected as we entered 2017 (Fed starting to hike, untested new presidential administration, several important European elections), few expected one of the least volatile starts to a year on record. Occasional single-digit VIX readings have been a byproduct of the exceptionally low realized vol. Contributing factors to this low RV include benign interest rate moves, stable economic growth, long gamma positioning, ongoing corporate buyback flows, low correlation, and a lack of major surprises.

Low correlation has dampened realized vol – but so has low single stock volatility. Low volatility has been seen across sectors, single stocks, regions, and asset classes.

Spikes increasingly short-lived. Any vol spikes we have had – whether based on anticipation (pre-French elections) or on news (Comey) have been unusually short-lived, as hedgers monetized positions once conditions seemed safe, and vol sellers resumed their activity. As a result, one vol metric that stands out is this year’s single-digit peak 3-week RV. The last time the SPX had 3-week RV above 10 was in the aftermath of November’s election. This consistency of low vol has helped longer-dated RV metrics become especially low, which has led SPX ATM implied vol to fall in an almost parallel manner across maturities year-to-date.

We expect vol to drift up. While there is no specific catalyst that we can identify to break this low-vol period, we expect vol to drift up toward more normal levels as the year goes on. Low vol can be hard to fight, so that doesn’t mean that buying options or buying vol will be profitable; instead we prefer trades that pair off long and short option positions to keep premium outlay contained as markets remain lethargic.

Vol1

Market Structure: Quick outbursts of vol have not brought follow-up vol – driving sharp reversals in short-term vol

Volatile moments have not turned into volatile periods. Several of this year’s most volatile moments (the Comey news, the tech selloff, Brazil’s selloff) saw both implied and realized volatility drop quickly post-event. Perhaps via investors monetizing just-in-time hedges purchased as protection for these specific moments may have helped implied vol drop.

Extraordinary vol-of-short-term vol. While we don’t love measuring vol-of-vol indices (preferring vol-of-tradable instruments like VIX futures or the VIX), we note that this quarter has been the VXST 9-day volatility index’s most volatile on record, as the post-French elections vol lull, the up and down of vol around the Comey news, and other mini volatile moments have driven unusually high short-term vol, followed by immediate reversals.

Efficient markets? In a sense market movements are getting concentrated in the bigger-vol days, interspersed with range-bound periods. This bears resemblance to efficient market hypotheses that expect markets to absorb new information instantaneously, yet we know that’s not how things work – as time passes, markets understand the impact of catalysts in new and deeper ways. What makes this new “efficiency” almost surreal is that in many ways this year’s market moves are harder to interpret than many past years’.

Just-in-time hedging is difficult – we prefer paired option strategies. While we appreciate the attractiveness of holding option positions for very short periods to reduce theta, given how expensive short-term options can become in the lead-up to an event and how quickly that premium can evaporate, we believe that risk reversals and other paired option strategies make sense as hedges that can be held for long periods without likely material time decay

Vol2

 

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