A Lull in Volatility
This week there was a pause in the “Euro ex-Greece” crisis and the plunge in Shanghai stock prices. In addition, Federal Reserve Chair Janet Yellen told Congress in her semi-annual testimony last week that the first Fed Fund target rate increase will come in 2015, and this week’s economic calendar was light.
No wonder there was a lull in volatility. TYVIX, CBOE’s real-time benchmark for Treasury volatility, decreased to 5.37 from 6.69 last Friday, which is below its median value to date, but still above its value a year ago. The VIX Index also edged lower, as did EUVIX, BPVIX and JYVIX.
Figure 1: Volatility Update
How long will the lull last? In Treasuries, TYVIX futures predict lower volatility until the end of November. October VXTY futures are ending the week close to 5.675, compared to 6.875 on June 29, when the contract month was first listed, and 4.7 percent greater than TYVIX. VIX futures, on the other hand, are more bullish on volatility. At 11:10 a.m. ET, the price of October VIX futures was 16.7, or 21 percent greater than VIX.
Figure 2. VXTY Futures -- June 1, 2005 – July 24, 2015
Are We Seeing the Calm Before the Storm?
The closest we have to a crystal ball is the skew of Treasury options, proxied by the difference between the TYVIX Index and the at-the-money volatility of CME 10-year Treasury options. The skew tells us the expected probability of a tail event in the prices of 10-year Treasury notes. On October 14, 2014, or one day before the flash crash, the skew reached .52, more than double its average value of .22 since the beginning of 2014 (.52 = TYVIX – ATM Implied = 6.31 - 5.79 ) The skew was .17 on October 15, 2014, and has averaged .39 since then.
As Figure 3 confirms, fear of another crisis event in Treasuries has indeed increased the skew since October 15, 2014 (blue bars). This is consistent with the pervasive concern of market participants over decreased liquidity in Treasuries.
The stock market looks more complacent, as reflected in a downward trend of SKEW over the same period (dotted black line). The CBOE SKEW estimates the perceived probability of tail events in the S&P 500.
Figure 3: Treasury Skew vs. S&P 500 SKEW
Flip Side of Lower Treasury Liquidity? Higher Intraday Volatility in VXTY Futures
Should lower Treasury volatility usher more crises, as the market currently fears, VXTY futures may be used to cushion the blow. The intraday volatility of the nearby VXTY contract (see High/Low in Figure 4) has ramped up along with the skew since May 2015.
Figure 4: High/Low of VXTY Futures and Treasury Skew since January 2015.
Article written by Catherine Shalen