So Many Roads

Twenty-five years ago (6/2/1995) the Grateful Dead began what would prove to be their final stand at the Shoreline Amphitheater. The Grateful Dead cultivated an exotic and far flung following. There was nothing standardized about their creative approach and it paid off.

In the mid-90s, options were still generally considered to be niche tools used by some eccentric types. Similarly, The Dead were stereotyped as an unusual band without broad appeal, despite a considerable and devoted following. My how things have changed in the past 25 years.

On June 2, 1995 the S&P 500 Index® closed at 532.51 and the Cboe Volatility Index® (the VIX® index) measured 12.98.

Pop Quiz: Which companies were the most valuable (market cap) in the middle of 1995?

#5: AT&T
#4: Wal-Mart Stores
#3: Exxon Mobil
#2: Ford Motor
#1: General Motors

From the high road, to the low: Sears Roebuck (#9), Kmart Holding (#15), JC Penney (#32). (Sears bought Kmart in 2004 for $11 billion. The combined company filed for bankruptcy protection in 2018. Two weeks ago JCP also filed for protection).

  • Netscape was worth about $5.4 billion and attracted about 90% of online traffic.
  • Amazon was launched in 1995 and IPO’d in 1997. [All I want is one (company) to take (everything I want) to my home…tomorrow].

In early July of 1995, during a crushing heatwave The Grateful Dead played their final shows in Chicago. The emotional crux of The Dead’s last set of music was So Many Roads. This Robert Hunter penned powerhouse could be construed in a variety of ways, but at the moment it may describe the path to reopening the global economy.

So many roads I tell you
New York to San Francisco
So many roads I know
All I want is one to take me home
From the high road to the low
So many roads I know
So many roads so many roads

Fast forward 25 years, Goldman Sachs analysts have created a US Reopening Scale that tracks the domestic progress between “Stay at Home” and “Back to Normal.” Wall Street types and media pundits have made commentary surrounding this their new bailiwick. Below is a visual from the New York Times that shows all 50 states having “reopened” or moved in that direction. Full article here.

Source: New York Times

Venturing to guess what the world and markets will look like in 2045 is a fool’s errand. In times like these, looking out more than a few days can be quite difficult. However, Cboe has a variety of volatility indexes that may provide a degree of prescience.

The VIX Index is recognized as the world’s premier gauge of U.S. equity market volatility. The VIX Index estimates 30-day expected volatility by aggregating the weighted prices of one-month S&P 500 Index (SPX®) puts and calls over a wide range of strike prices.

Cboe also calculates VIX9D℠, VIX3M℠, VIX6M℠, and VIX1Y℠ that all use SPX Index options as inputs. The differences are a matter of tenor. At the moment, relative measures remain elevated from a historical perspective across the volatility surface. Below is a look at the various VIX Index measures as of May 28, 2020 compared to the same measures at the beginning of June in 2019. 

Source: Cboe Global Markets

Clearly the entire curve has shifted meaningfully higher over the course of the past year. The shape has been altered as well, and it’s most pronounced by the current VIX6M level. So, what are SPX options that expire ~6 months in the future currently pricing in?

  • 11/2/2020 U.S. Elections
  • The start of the next “flu season” in the northern hemisphere and the potential for a 2nd (or 3rd) wave/mutated virus

Year-over-year, VIX6M has advanced more than any of the other measures. It’s higher by 67% relative to the start of June in 2019.

Now let’s zoom out a bit and introduce some more perspective. What if we incorporate the various VIX measures from mid-March 2020? The scale is going to change dramatically……


Source: Cboe Global Markets

So many roads, so many roads.

Remember, the volatility surface describes a multi-dimensional plot that illustrates maturities (time until expiration) along the X-axis, implied volatility levels along the Y-axis, and strike prices on the Z-axis.


Source: MathWorks

Implied volatility (IV) is the great unknown in any option pricing model. As such, it’s often considered the linchpin for success in options trading. Implied volatility measures have a tendency to converge (flatter vol smile) across strikes for long-dated maturities (reference above). During times of market duress, shorter-dated maturities tend to have much more pronounced IV levels than longer-dated maturities.

This is similar and related, but distinct from the VIX futures term structure, which we’ve addressed in previous newsletters.

The long end of the vol surface may not be a cynosure for option traders with shorter opportunity windows, but huge amounts of capital have one-year (or longer) mandates. VIX1Y is, at its essence, a dynamic (updated every 15 minutes when SPX options are open) forward volatility expectation based on SPX options with a year until expiration. For those interested in a deeper dive into the methodology for VIX1Y, which mimics the methodology applied at other durations, click here.

A wide variety of institutional types focus specific attention on the one-year forward time horizon. They include insurance firms offering annuities, banks that sell structured products, unit investment trust (UIT) companies (closed end funds), and more recently, defined outcome ETF creators like Cboe Vest and Innovator Funds, which have seen massive AUM growth over the past few years.

Yet again, this is arguably an instance where Cboe Strategy Benchmarks helped facilitate greater understanding and eventually the adoption of optionality. Cboe’s BXM℠ (2002) provided a historical narrative for S&P 500 Index Buy Writes, which begat institutional allocations. Eventually the Index Buy Write suite expanded to include the FTSE Russell® 2000 (BXR℠) and MSCI® Indexes (BXEA℠ and BXEF℠). There are variations on these benchmarks as well as put write and other Indexes. Capital has followed in every case.

More recently, Cboe created a number of Target Outcome Indexes. The aforementioned ETF creators have introduced liquid tradable alternatives to structured products. The growth in this corner of the market has been nothing short of spectacular. There’s very clearly demand for buffered/enhanced market exposure without the counterparty risk and illiquidity typically associated with structured notes.

In related news, market participants have become aware of the tremendous utility afforded by Index FLEX® products. These cutting edge defined outcome products have readily adopted FLEX trading and the product has experienced massive growth.

Curious? – There is more information available at Cboe’s FLEX site. For the sake of brevity, the distinguishing characteristics include:

  • Fully customizable contract terms (includes strike price, exercise style, and expiry)
  • Point-to-point trading precision (EX: 100%-110% SPX call spread)
  • Central Clearing (OCC) that mitigates counterparty risk
  • Deep liquidity pools as opposed to single bank/bilateral agreement
  • Exotics, like Asian and Cliquet options readily available

Stay tuned because the next edition of INSIDE VOLATILITY will include a deeper dive into exotic options like average price and monthly resetting options, so many roads…

We’ve covered a lot of ground already, so let’s wrap with some market highlights from recent weeks:

Small Caps (RUT℠) have been ripping higher since May 14, advancing by ~20% while the DJX +12%, SPX +9.8%, and NDX +6.7%. Perhaps leadership is shifting. It’s unusual to see “big tech” (NDX) lagging. 

For those with a glass half empty view, Toroso Advisors SVP and PM, Jim Carroll recently pointed out that the one-year moving average on the VIX Index pushed beyond 20, which has generally only occurred during more prolonged periods of macro vol. This isn’t to imply that history repeats, or we can’t move back into a much more normal vol regime soon – anything is possible.

In my conversation with Jim Carroll he made some salient and self-aware points:

“Conclusion is not on the current list of safe words, but my observation is that VIX, VIX3M, and VIX6M are all still right around the 90th percentile of their historical values. The one-year moving average of VIX is above 20 for the first time since 2012 after crossing that line in March 2008. That suggest that we may be moving to a high vol regime where the range of SPX returns will be wider than most investors want to see.”


Source: Toroso Advisors

From the land of the midnight sun
Where the ice blue roses grow
Along those roads of gold and silver snow
Howlin’ wide or moaning low
So many roads I know
So many roads to ease my soul

Robert Hunter


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