Since peaking during Christmas just a couple months ago, the VIX has steadily declined through the start of 2019.
The 30+ VIX observed in December now feels like a distant memory, with the popular volatility metric now trading once again below it's historical average of 19. As of February 21st, the VIX had even broken below 14, and closed the session trading 13.51.
Given the longtime and strong inverse correlation between the VIX and the S&P 500, it will surprise exactly no one that the SPY has rallied throughout that period as well. Retaking 280+ in late February, the all-time highs in SPY notched last fall (293) are now once again in sight.
As of now, the qualitative narrative in the financial markets appears to be following (or leading) what's been observed in the VIX and SPY.
Market uncertainty has declined in the first two months in 2019, purportedly because the likelihood of a trading “truce” between the US and China is higher than ever. This was confirmed when the Trump administration announced in late February they were delaying additional tariffs on Chinese goods - an increase that was expected to be instituted on March 1st, 2019.
Despite the optimism, it's still too early to predict how the final agreement will look. Given how closely President Trump appears to follow the stock market, all indications suggest he will reduce his list of demands in order to put a deal in place that placates international financial markets.
Whether that's prudent or not, is of course another matter completely, with both sides of the fence possessing strong reasoning one way or the other.
One point that most would agree upon is that a truce between the Americans and the Chinese removes one big headwind to the global economy. However, looking further down the road, if the Chinese haven't conceded to any of the changes first sought by the Trump Administration, then what's really been achieved?
Getting back to the current landscape of volatility, the VIX has declined methodically in the last couple of months, but what about other parts of the volatility time horizon? The VIX that most market participants follow measures near-term implied volatility (~30 days), but what insights can be discovered by looking further out on the time horizon?
This was the precise topic investigated on a recent episode of Market Measures, and we think the data presented on the show is worth a few moments of your time.
Outside of the normal 30-day VIX, the Chicago Board Options Exchange (CBOE) also maintains volatility metrics for other time horizons, including: 9-days, 3-months, and 6-months. The graphic below highlights a snapshot of the levels in each of the four VIX products as of late February:
As you can see in the data above, the longer-term VIX products reveal that implied volatility further out on the time horizon remains elevated.
In order to provide further illumination on the current term structure of implied volatility, the Market Measures team took the analysis one step further. They decided to look back in history and see whether selling premium during instances in which 9-day implied volatility was higher than 30-day implied volatility produced a higher return when compared to selling in “all environments.”
A backtest was designed using the following parameters:
Used historical data in SPY from 2011 to Present
Backtested short 20-delta strangles
Compared “all environments” to only instances in which “9-day VIX was greater than regular 30-day VIX”
All positions were held through expiration
The slide below provides a summary of the findings:
As you can see in the graphic above, the data in this study didn’t produce a convincing argument for getting more aggressive when 9-day VIX is elevated above 30-day VIX, at least in historical terms. Compared to “all environments,” the win rate and average P/L were lower using 9-day volatility as a guide for trade entry.
The hosts discuss on the show how Implied Volatility Rank is still preferred when making trade entry decisions, as opposed to any particular level in one of the VIX metrics (9-day, 30-day, 3-month, 6-month).
In terms of the VIX, short premium traders can use this metric as a guide for capital management. Being less aggressive in low volatility environments, and potentially more aggressive in high volatility environments - depending of course on your own unique trading approach and risk profile.
We hope you’ll review the complete episode of Market Measures focusing on VIX term structure when you schedule allows. If you want to take the deep dive on the VIX, then we also recommend a new episode of The Skinny on Options: Abstract Applications.
If you have any questions about this material, don’t hesitate to leave a message in the space below, or reach out directly at firstname.lastname@example.org.
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.
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