Who wants to talk some more about the low vol. regime?
Why, everybody of course! That’s the “great” thing about persistently suppressed vol. – if nothing is moving, the only thing to talk about is why.
This has been parsed to the point of absurdity. Unless your name is Aleksandar Kocic, there is virtually no chance that you have anything new to add to the discussion. But again, until cross-asset vol. picks up, we have to keep talking about the fact that it’s suppressed because if we don’t, we won’t have anything else to discuss. Allow us to quote ourselves again (because nothing says arrogance like consistently quoting oneself):
Volatility has become the market’s perpetual topic du jour (does it make sense to use “perpetual” and “du jour” in the same sentence? Not sure on that).
Suppressed vol has become ubiquitous. And the amusing thing about ubiquity is that it has a way of making everyone think they’re entitled to have an opinion on whatever it is that’s ubiquitous. That’s certainly the case with volatility.
That’s the (black) magic of VIX ETPs. Hordes of retail investors have been transformed virtually overnight into futures traders much the same way as the rampant proliferation of margin debt in early 2015 helped turn every bored housewife in China into a leveraged Shenzhen day trader.
This dynamic has created a veritable cacophony of explanations as to why vol is so low.
Well on Tuesday, Goldman is going to add to that cacophony and that’s fine because while they don’t have any Aleksandar Kocics on staff, they’re still Goldman which means that even when they’re saying nothing, they’re still saying something.
Got that Monix?
So the Squid has an expansive new note out that explores all angles of this and what we thought we’d do here is hit the high (err… ‘”low”?) points and then follow up later. So first is a reminder that low vol. is “one of the market stories of the year.” To wit:
The VIX’s lowest, tightest trading range on record points toward inexpensive short-dated S&P 500 options:
- Sharp contrast from 2016. Less than 12 months after the initial reaction to US election results drove the front-month VIX future above 23, front-month VIX futures’ intraday peak for the year has been 16.7.
- Low VIX has come to symbolize complacency. The falling VIX this year has often been associated with complacency regarding expanding valuations. If anything, though, it’s the slow and steady movement of the S&P 500 that’s exhibiting complacency, and a VIX around 10 is not unusually low given the context of underlying equity volatility around 7%.
- Most of this year’s VIX range has been below past years’ lows. 2017’s 85th percentile VIX close is below 2016’s 15th percentile close, and this year’s 75th percentile VIX close (11.8) is below the 5th percentile of the prior five years’ range.
- Investors cannot buy the VIX – but can buy SPX options. VIX futures, options, and ETPs have different economics from buying/selling the VIX itself. The low VIX most directly points toward record-low option prices – investors who need hedges to add to longs, or who have strong short-term views will find options affordable. Hedging against a pullback into year end can provide significant leverage: a 15-Dec 2500-2425 put spread would pay off around ten times its current premium at expiry if fully in the money. High skew and low vol make put spread multiples near the highest on record.
So there’s a common sense idea for anyone that wants to hedge, but then again, hedging is for “witches.”
And now for the ubiquitous listing of the crazy statistics:
This year’s low vol has been steady: it has not been driven by the lack of a single high vol moment, nor by an extraordinarily low-vol month or two. On a day-to-day basis volatility has been subdued in the SPX and in global equity markets:
- It has been over 50 years since realized vol was as low as this year’s 7%. 2006’s 10% was the lowest SPX volatility of the lull between the dot com selloff and the financial crisis. The lowest annual SPX realized vol years on record are 1964 and 1965 with 5.3% and 6.8%, respectively.
- The lack of volatility has corresponded with a lack of selloffs. The largest selloff this year (closing low versus any prior high) has been 3%; 10-month periods (we are 10 months into 2017) without a 5% selloff in less than a month have been historically uncommon. October is on track to be the 12th month in a row with a positive SPX price return – the first time since 1935-6 that has happened.
- The SPX has moved by less than +/- 20bp on 53% of days this year (which would be the lowest ever for a calendar year). Daily moves below 50bp have happened on 80% of trading days.
- The lack of a high-vol, high-fear period has left the markets’ potential for volatility in a selloff untested. Despite range-bound volatility conditions, volatility has been sensitive to spot SPX moves, and measures of vol-of-vol have been above-average. This leaves an untested potential for a substantial vol spike pushing the VIX into the 20’s should the SPX actually see a quick several-percent selloff.
If all of that sounds absurdly precarious to you, that’s because it is. Although, as long as the central bank-market communication loop remains intact and the fourth wall isn’t rebuilt, this can presumably continue right up until something forces central banks’ hand. Here’s DB’s Kocic:
Predictable monetary policy and tightly controlled Fed exit, in general, defines the background against which everything else will play out. Fed is long an option to hike (or not to hike), depending on the market conditions and assessment of market’s reaction – they can expand their reaction function/mandate in such a way that it keeps smooth operation without raising the fear of tail risk. At the same time, Fed is running a risk of upsetting the markets and/or creating a perception of eroding confidence. Fed is short a “credibility” option – their actions have to be credible and the market must not challenge them. This “credibility” short has been the major source of volatility supply to the markets – the reason why, despite all the risk associated with policy unwind, carry trade and volatility selling remain dominant across a range of market sectors.
Withdrawing that option, i.e. being less transparent, and less concerned about the market reaction, could raise the stakes and push vol levels higher. It would restore risk premia as it would represent an implicit withdrawal of convexity supply to the market. However, Fed’s transparency is the key factor for managing risk of their exit. It is unlikely that they would willingly give it up. We see inflation and deficit spending (releveraging) – anything that would cause a substantial bear steepening of the curve – as the only factors that could force Fed’s hand.
Until then, remember:
Vol. selling isn’t just a trading strategy, it’s a lifestyle. Welcome aboard.
Oh, and if you see a vol. spike, you try to kill it, ok?
It’s not a pet.