So here’s a question. If the market keeps going up and up across multiple sectors, why does that not impact volatility. It’s statistically a deviation from a median, at least the median yesterday. And clearly, across the market, the deviation from yesterday’s median fluctuates on any given day. If stocks were dropping, we would see the VIX increase. So, why doesn’t volatility increase when the market increases as a whole? Money is indeed going in. In other words, WTF?
well, don’t forget about correlations diving. and about dealer hedging (i.e. someone has to take the other side of the short vol. trade and those long gamma positions reinforce local stability). Here’s Marko Kolanovic’s quick recap:
Market volatility collapsed in 2017, and our view is that it will gradually increase next year. Average level of VIX of ~11 in 2017 may increase to an average level of ~13-14 in 2018. Volatility will likely be contained in the first half of the year, and then increase in the second half. In 2017, VIX was ~10 points below historical average. Out of those 10 points, our analysis shows that ~1/3 can be attributed to a temporary decline of stock correlations, ~1/3 to supply of volatility and temporary effects of daily gamma hedging, and ~1/3 to positive macro fundamentals and stability. Record low correlations between stocks are very likely to increase after the tax reform gets fully priced-in in the second half of 2018. We estimate this will push index volatility up by ~3 points. Perhaps the best example of the impact of correlation on reducing S&P 500 volatility was the market move on Nov 29, when financials and technology stocks moved ~4% relative to each other leaving the S&P 500 index price unchanged (~5 sigma move).
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