If you were one of the people complaining about historically low levels of volatility this past summer you're likely doing cartwheels in the current market environment.
The VIX has risen roughly 9 points over the last 10 days and currently trades 22 and change, which is well ahead of the low-teens prints observed for most of June-August.
As we highlighted in a previous blog post, many are attributing the current melt up in the VIX to uncertainty related to the US Presidential election. However, it should be noted that is only one theory - it's entirely possible that an increase in realized market volatility could materialize in the near term for another reason (Syria, Brexit, Italy, etc...).
Because context is always a key component of understanding, the Market Measures team decided to tackle VIX 22 and conduct an objective analysis on how these levels compare to recent history. We think the results of this examination are certainly worth a few moments of your time.
As you'd probably expect, the spike in VIX has translated into increased Implied Volatility Rankings (IVRs) across the board. On the episode, the guys present a slide showing that some of the market's major barometers are now trading significantly higher in terms of IVR:
As a reminder, IV Rank simply tells us whether implied volatility is high or low in a specific underlying based on the past year of implied volatility data. For example, if XYZ has had an IV between 30 and 60 over the past year and IV is currently at 45, XYZ would have an IV rank of 50%.
As you can see from the above, SPY and IWM are currently trading at IVR levels above their averages as compared to the last year of data.
Getting back to the VIX, recent history reinforces what we observe in market-wide IVRs. Below is a chart showing the distribution of VIX prices since 2004:
The VIX has averaged around 19 since its inception, so it's not surprising to see the bulk of instances charted above falling below the current level of 22.
Equally important is how long the VIX stays elevated once it does break above its historical average. Volatility traders are essentially banking on mean reversion - the assumption that a financial instrument's price will tend to move to the average price over time - so the average time table of mean reversion in the VIX is also an important data point.
In order to better understand how long the VIX has remained at elevated levels in recent history, the Market Measures team researched the number of days the VIX stayed above 20 once it got there.
Data since 2004 produced the following averages (# of consecutive days with VIX above 20):
Longest Streak: 305 days
Average: 14 days
Median: 2 days
It's important to note that the window of time considered for this VIX analysis did include the 2008-2009 Financial Crisis, which in the entire history of trading certainly stands out as unique.
There’s no telling what may develop in the markets during the remainder of 2016 and into the new year. The best one can do is deploy a disciplined strategy and ensure that risks are carefully managed across varying market environments. Depending on your view, the current spike in VIX may represent an opportunity - or a signal to reduce risk.
If you want to learn more about volatility and mean reversion this post on the tastytrade blog is a great starting point.
As always, we hope you’ll reach out at firstname.lastname@example.org with any comments or questions.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.