How Broken Is The Vol Complex?

I’ve talked at length over the past year about imbalances in the vol complex and associated extremes in “crash” pricing.

Admittedly, vol market “brokenness” is a kind of fallback theme for me — a perpetual topic du jour that always “works.” It’s an engaging subject.

The above-mentioned extremes are still evident. Nomura’s Charlie McElligott described crash pricing as “eye-watering” across US majors earlier this week. Again, it’s part real angst and part “bad” optics tied to supply/demand mismatches.

Although I don’t have anything particularly fresh or novel to add, I did want to highlight some new commentary from Goldman’s Rocky Fishman and SocGen’s equity derivatives team which, together, underscores the point.

In a note out earlier this week, Fishman observed that one-month realized has “never been this low with the VIX over 30.” Although realized jumped sharply on the heels of the Omicron scare and Jerome Powell’s hawkish pivot, Fishman noted that despite the longest stretch of consecutive +/- 1% moves since the election, the increase in realized didn’t keep pace with implied.

When the closing bell sounded on a second consecutive weekly decline for the S&P last week, the VIX sat at 30 while one-month realized volatility was still just 14%. That 16-point premium, Fishman noted, was 99.7th%ile (figure above).

Further, December 1 and December 3 went down in history. On those days, one-month realized was the lowest ever when the VIX closed above 30. As Goldman’s Fishman went on to say, “the closest historical match to this combination was the lead-up to the January 2021 short squeeze.” That’s no coincidence. Both stretches where characterized by elevated single-stock option volume.

In their latest volatility outlook, SocGen’s Vincent Cassot and Jitesh Kumar wrote that “high demand versus relatively constrained volatility supply continues to particularly impact left-tail risk pricing.” To that point, they updated a poignant chart.

The figure (above) shows “options that are more than 15% lower than the current spot account for a very high percentage of the VIX’s theoretical value,” they went on to say, adding that “this left-tail was especially stretched post [Black Friday’s] selloff.”

This is creating the appearance of extreme risk aversion. I say “appearance” not to suggest that folks aren’t actually risk averse or that risk aversion isn’t warranted. Rather, I want to emphasize how this has become a kind of funhouse mirror.

Fishman captured it well. “As an example of how expensive VIX tail hedges have become, a January 85-strike call, which would only pay off if the VIX closes above its current all-time high, costs the same amount as a 20-strike put,” he wrote, earlier this week. “The VIX has closed below 20 on over 60% of trading days in its history.”