The recent move lower in implied vol is “an opportunity to add short-dated hedges,” according to Goldman’s Rocky Fishman.
Over the last several months, I’ve dedicated quite a bit of digital ink to the supply/demand imbalance that kept implied vol stubbornly elevated, even as realized fell. This discussion is familiar to regular readers. A variety of factors conspired to keep forward vol “stuck,” if you will. Late in February, JPMorgan’s Marko Kolanovic described similar distortions to those outlined in the linked article, noting that the VIX had become increasingly disconnected from underlying short-term realized. “The spread between the VIX and two-week realized vol sits in the 99.6th percentile going back three decades,” he wrote.
More recently, the situation began to normalize. Macro Risk Advisors’ Dean Curnutt this month said that with equity index option premiums having “finally squared with the level of realized volatility… options [may offer] a far fairer deal than at any time post-pandemic.”
A reversal in apparent hedging interest via the VIX ETNs is among the factors that have helped ease some of the tension in the vol complex. “The aggregate VIX ETN Net Vega position has decreased by nearly $85mm from the earlier YTD highs as prior long-vol hedges were reduced or monetized, allowing iVol to further soften from the ‘sticky higher’ levels experienced the first few months of the year,” Nomura’s Charlie McElligott remarked last week.
Goldman’s Fishman thinks that’s a bit odd. “We are especially surprised at the lack of inflows into long VIX ETPs, which historically have drawn inflows when volatility hits the bottom of its range,” he said, before noting that “even though we see a continued reduction in supply of volatility risk,” an abatement of demand permitted a decline in volatility risk premium.
With short-dated implied on key benchmarks no longer disconnected versus pre-COVID levels, it may make sense for investors to eschew smaller longs in favor of larger, but hedged, positions, Fishman suggested. Put differently, if you’re concerned about stretched valuations and the prospect that all the good news is already “in the price” for equities just as higher taxes and policy uncertainty become visible on the horizon, hedging your equity positions may be preferable to actually reducing equity length, given the risk of missing out on further upside into a prospective summer economic boom.
Notably, Fishman juxtaposed 2021 with the past three years, a period when new highs in stocks were sometimes met with a higher VIX. “While negative volatility-spot correlation is not unusual, it is a break from the trend,” he said.
He went on to compare the current conjuncture with 1997 and 1998, also years that saw the market transition from an environment of rising vol at fresh highs to lower vol with successive peaks. “In each of those years, the aftermath of a major event left a period of new VIX lows with each SPX high, but markets became much more volatile soon thereafter in each case,” Fishman wrote.
The bottom line: Goldman sees a swift return to a regime characterized by high volatility risk premium considering jitters around valuations and other event risks. So, if you were looking for a window to add “tactical” hedges, this may be it.
