Maneesh Deshpande from Barclays discussed The Current Volatility Environment today at CBOE RMC Europe. In a wide-ranging talk, he covered the current low volatility regime, how VIX related ETPs may be impacting the derivatives markets and addressed the common question, “How low can VIX go?”.
He started out addressing the question, “Why is VIX low?”. He noted that realized volatility has been very low, but this is common during market rallies. He also pointed out that inter-sector correlations are low which is resulting in the low realized volatility of the S&P 500. In discussing low correlations across market sectors Maneesh stated that policies in the US has had varying impacts on different sectors.
He addressed a common question with respect to the potential impact of VIX related derivative trading on volatility levels. He noted that short VIX futures exposure is supplying liquidity to long volatility demand. Stated another way, short volatility trading is not necessarily driving the direction of volatility. He did note the main impact of VIX ETP positioning is on the VIX term structure as opposed to spot VIX.
He also discussed buy write funds noting that the assets under management have increased 15 fold in the last 16 years, but also noting that recent growth for these funds has been stagnant. He discussed buy write fund exposure in terms of gamma noting that the gamma exposure has increased, but explaining this as being a function of low volatility.
Addressing the question, “How low can VIX go?” Maneesh noted that realized S&P 500 volatility was lower in the 1960’s than it is today which would have likely translated into a lower level for VIX. A fitted value for VIX places VIX below 10 for 10% of trading days in the 1960’s. He also addressed this question with respect to SPX convexity noting that if convexity returns to a normal level, 1.5 points could come out of VIX levels.
A final question he rhetorically asked was, “What will happen if VIX spikes”? Based on historical price reactions a 5% drop in the S&P 500 would result in a 15 point jump in VIX which would take the front month futures contract up by only 7 points. There is concern that VIX ETPs may exacerbate a move in VIX, but Maneesh noted there are participants on both sides of the long and short VIX ETPs which balances out the potential impact of trading on VIX futures pricing.