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Posted: 12 Apr 2014 11:00 AM PDT
The first day for VXST option trading is history and what a day it was in the equity markets with the S&P 500 losing just over 2% and the NASDAQ-100 dropping over 3%. Operationally trading in the new VXST option market was smooth as any established market despite the extra equity market volatility. Just before the close I spoke to some traders in the VIX pit and I was a little disappointed to hear that none of the trades today appeared to be spread trades. I do believe in time some very clever volatility traders will find methods of combining various VXST options (or even VXST and VIX together) to come up with their desired exposure to market volatility. The day over day activity in VXST and the current futures contracts appears below –
Note VXST rose about 30% and the front week April 16th VXST Future was up over 20%. Any time we have seen a rise in equity market volatility over the past couple of years the result has been a quick drop back to lower levels. The 0.75 discount for the near dated VXST future relative to the index can be taken as the volatility market expecting some sort of drop in the index as well.
On a final note, the biggest VXST option trade was a purchase of just over 2,000 of the VXST Apr 16th 16 Calls for 0.30. This trade actually went off pretty early in the day when VXST was at much lower levels. Whoever was behind this trade is probably pretty happy with VXST options as the bid price on this option was 0.95 on the close today. Not so bad for a first VXST trade.
VIX Properly Reflecting Fear
Posted: 12 Apr 2014 07:39 AM PDT
Over the past couple of weeks I have been out and about representing CBOE and The Options Institute in diverse places such as Schaumburg, IL, San Jose, New York, and Omaha, NE. On these travels I have often been asked about the persistent low level for VIX despite pockets of weakness in the stock market. Yesterday is a prime example as the S&P 500 sold off over 2% and VIX closed the day under 16.00. My understanding is that it was mentioned on one of the business networks this week that investors have more alternatives to hedge so VIX does not reflect fear as it once did. I could not disagree more with that statement. VIX reflects the lack of fear and is correctly doing so. The chart below shows daily closing prices for VIX and the S&P 500 from the beginning of 2014 through the end of the first quarter in 2014 and is a good illustration of why I believe VIX is properly reflecting the lack of fear.
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Note the four places on the chart above where I have highlighted spikes in VIX over the past 15 months. The S&P will have hit a small rough patch and VIX moves up based on concerns that the market drop may turn into a protracted correction or bear market move. Now note what happens after these spikes in VIX, the S&P 500 resumes a move to the upside and VIX returns to lower levels. This pattern continues to repeat itself investors and traders become less fearful of the next drop. The last real volatility event in the US occurred back in August 2011 which seems be quickly becoming a distant memory for many traders.
Part of the argument about VIX not reflecting fear is that there are more alternatives to hedge against a drop in the equity market. This is an argument that I have a tough time with when I consider exactly what VIX represents. VIX is the implied volatility of options based on the S&P 500 or SPX Index options. Average daily volume for SPX option trading in 2013 was about 823,000 contracts which was a 17% increase over 2012 average daily volume. So far in 2014 average daily volume for SPX options is running at about 870,000 contracts. Many listed markets in the US have been experiencing negative or flat volume growth. If there are new hedging alternatives that are impacting the level of VIX this would mean that SPX volume should be shrinking, not growing.
VIX is doing what it has done for over 20 years – it is properly reflecting the lack of concern in the market when the S&P has a day like yesterday. The market has become accustomed to small corrections followed by a new high in the S&P 500 and VIX is quantifying that complacency through being a relatively low levels. When we get the next real volatility event that should quiet the critics that say VIX has undergone some sort of change – fear will return and with it higher levels for VIX.
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