On June 1st the CBOE Volatility Index® (VIX®) closed at 9.89. June 1st marked only the 14th day on which the VIX Index closed below 10 (its price history begins in 1990). Six of the 14 days on which the VIX Index closed below 10 occurred in 2017 (see Exhibit 1 below for a list of all 14 dates).
REMARKS AT CFA ANNUAL CONFERENCE
On May 21 through 24 I listened to several outstanding speakers 70th CFA Institute Annual Conference in Philadelphia. Speakers’ remarks that were among the most interesting and relevant to me were on the topic of the current levels of volatility and the VIX Index. I found the following volatility comments of two speakers particularly intriguing --
- In a Q&A session on May 21, Richard H. Thaler, the Charles R. Walgreen Distinguished Service Professor of Behavioral Science and Economics at the Booth School of Business, University of Chicago, answered a question on volatility by noting that the current low level of the VIX Index was the biggest [financial] mystery of our time, in light of the fact that we live in a time of great uncertainty, regardless of one’s political views, and whether or not one is supportive of the program of the current U.S. President. Professor Thaler said we face surprises when we read early morning tweets, and that when animals are afraid, they often freeze up.
- In her prepared remarks on May 24, Abby Joseph Cohen, CFA, Advisory Director and Senior Investment Strategist, Goldman Sachs & Co., noted that realized volatility for major indices sharply declined following Euro-zone worries in late 2011, but realized volatility is now increasing. In answer to a question about concerns for future volatility, Ms. Cohen said she was even more concerned about the potential for future higher bond market volatility when compared to future equity market volatility.
In addition, minutes from the Federal Reserve in early 2017 “expressed concern that the low level of implied volatility in equity markets appeared inconsistent with the considerable uncertainty attending the outlook for … policy initiatives …”
VIX INDEX VALUES
The CBOE Volatility Index (VIX) is a measure of market expectations of 30-calendar-day volatility conveyed by S&P 500 Index (SPX) option prices. The VIX White Paper notes that the VIX Index estimates expected volatility by averaging the weighted prices of SPX puts and calls over a wide range of strike prices. The selected options are out-of-the-money SPX calls and out-of-the-money SPX puts centered around an at-the-money strike price. I recently have heard comments and questions on the topic of why the VIX Index recently has been lower than its long-term average, and I also have been asked if there continues to be interest in hedging of downside risk in stock portfolios. The average of the daily closing values on the VIX Index was 19.7 in the 27 years from 1990 through 2016, but only 11.8 year-to-date in 2017 (through June 1).
EXHIBIT 1 – VIX INDEX CLOSED BELOW 10 ON 14 DATES
EXHIBIT 2 - VIX INDEX SINCE 1990
While some commenters point to macroeconomic factors and Fed policies that could impact the levels of VIX, below are three discussion points (re: skew, historic volatility, and term structure) with charts that help better explain the relatively low level of the VIX Index.
HIGH SKEW AND MORE INTEREST IN HEDGING SEVERE DOWNTURNS
While the VIX Index recently has been below its long-term average, there still has been strong demand for use of stock index options to hedge severe downturns in the stock markets.
So far in 2017, there usually has been a relatively high volatility skew for SPX options, in that the implied volatility for the out-of-the-money (O-T-M) SPX put options usually has been much higher than the implied volatility for the at-the-money (A-T-M) SPX options. Bloomberg’s estimates average 30-trading-day implied volatilities for SPX options in 2017 were (through May 25): (1) about 31.7 for SPX options at 80% moneyness (this implied volatility could apply to SPX protective put options that are 20% out-of-the-money), and (2) about 9.2 for SPX options that are at 100% moneyness (or at-the-money).
EXHIBIT 3 – SPX OPTIONS IMPLIED VOLATILITIES – CHART WITH ESTIMATES FROM CBOE LIVEVOL
A metric that investors can use to track the relative demand for disaster protection is the CBOE SKEW Index, which is calculated from weighted strips of out-of-the-money S&P 500 options, and rises to higher levels as investors become more fearful of a “black swan” event — an unexpected event of large magnitude and consequence. If there were no tail risk expectations, the SKEW Index would be equal to 100.
EXHIBIT 4 - CBOE SKEW INDEX
The averages of the daily closing values of the SKEW Index were 118.4 in the 27 years from 1990 through 2016, and 134.5 in 2017 (through June 1).
VIX INDEX HAS BEEN HIGHER THAN SPX HISTORIC VOLATILITY
While some people have recently questioned as to how the VIX Index values could be in a “low” range from 9.7 to 12 on most days in the past month, one should note that the historic volatility of the S&P 500 Index recently has been even lower than the VIX. When compared to SPX historic volatility, one could argue that VIX has not necessarily been “low.” The averages of daily closing values in May (through May 30) were 10.9 for the VIX Index, 7.4 for the 30-trading-day historic volatility of the S&P 500 Index, and 4.6 for the TYVIX Index (an index that reflects the expectations of interest rate volatility; in her remarks, Abby Joseph Cohen expressed concern about the possibility for a spike in interest rate volatility).
EXHIBIT 5 – RECENT VOLATILITY SINCE MAY 1ST
TERM STRUCTURE - VIX FUTURES PRICES ARE HIGHER THAN VIX SPOT PRICE
For those folks who ask about the “low” level of the VIX Index, one response would be to say that folks are welcome to explore the prices of the tradable VIX futures. As shown in the VIX futures term structure chart below, the quoted prices were 10.59 for the VIX spot index, and the quoted prices for the VIX futures (which are based on the forward values of the VIX Index, and reflect expectations of 30-day volatility at future dates) ranged from 10.90 for the VIX futures expiring on June 7, to 17.40 for the VIX futures expiring on February 14, 2018.
EXHIBIT 6 – VIX TERM STRUCTURE IS IN CONTANGO AND UPWARD-SLOPING
FOUR BENCHMARK INDEXES
For investors who are interested in equity portfolio protection with SPX options at times when price-earnings ratios are relatively high, and the VIX Index is at relatively low levels, four benchmark indexes that could be explored are:
- CBOE S&P 500 95-110 Collar Index (CLL) - purchases stocks in the S&P 500 index, and each month sells SPX call options at 110% of the index value, and each quarter purchases SPX put options at 95% of the index value. www.cboe.com/CLL
- CBOE S&P 500 Zero-Cost Put Spread Collar Index (CLLZ) - track the performance of a hypothetical option trading strategy that 1) holds a long position indexed to the S&P 500 Index; 2) on a monthly basis buys a 2.5% - 5% S&P 500 Index (SPX) put option spread; and 3) sells a monthly out-of-the-money (OTM) SPX call option to cover the cost of the put spread. www.cboe.com/CLLZ.
- CBOE VIX Tail Hedge Index (VXTH) - buys and holds S&P 500 stocks, and also often buys 30-delta call options on the CBOE Volatility Index (VIX). www.cboe.com/VXTH.
- CBOE S&P 500 5% Put Protection Index (PPUT) - strategy that holds a long position indexed to the S&P 500 Index and buys a monthly 5% out-of-the-money (OTM) S&P 500 Index (SPX) put option as a hedge. www.cboe.com/PPUT.
For people who ask me about the VIX Index recently being much lower than its long-term average, I suggest that they look at the following three factors to gain a fuller picture of implied volatility, and the interest in and costs for hedging strategies –
- The SPX skew and the related SKEW Index have been relatively high in recent years, and there still is strong demand for hedging severe downside risk;
- The VIX Index generally has been higher than the historic volatility of the S&P 500 Index in 2017 (using this comparison, one could argue that the VIX has not necessarily been “low”); and
- While the VIX Index was valued at 10.68 on the morning of May 30, the VIX futures term structure chart showed that most tradable VIX futures were priced higher than the VIX spot index.