The VIX and the Volatility Conundrum : Either something awful is about to happen , or it's all a
ref :- Short View by Miles Johnson , The Financial Times, Companies and Markets
If you're one of those who struggles to get your head around Volatility, or perhaps more pertinently has questioned its true worth as a trading tool when the rest of the world pores over its every move, it turns out that your instincts may not so offbeat after all. At least, that's one of the conclusions examined by Miles Johnson in today's FT.
First of all, a definition reminder :
The CBOE Volatility Index, or VIX, is a measure of short-term market volatility constructed from the implied volatility of S&P 500 stock index options. It is calculated from the price of both Put options (to sell) and Call options (to buy), and is a measure of market risk, often referred to by investors as "The Fear Gauge".
Right now, US stocks are once again at record highs ..... and volatility as measured by the VIX, if not quite making record lows, is at or near its lowest for about 24 years. That's the conundrum of the title ..... at least it is for those of a bearish bent. Their reading of the situation, which undeniably has a certain logic even if you don't buy into their conclusion absolutely, goes essentially as follows :
Violent corrections occur when investors are complacent about risk ..... Investors have been extremely complacent this year as evidenced by ultra-low levels of volatility measures ..... Ergo, the likelihood of a violent correction is extremely high.
Just about the most interesting thing about this remarkable period of low volatility, which of course suggests a particularly relaxed attitude amongst investors which some might call complacent, is that if you listen to many of them they sound anything but complacent ..... or indeed relaxed. By some measures, large institutional investors are more nervous today than at any time since the dotcom bubble was about to burst.
The most recent Bank of America Merrill Lynch survey of fund managers showed that 44% of respondents believed equities to be overvalued. That's the highest reading since 1999 .... and the proportion of portfolios being put into cash is also on the rise, suggesting that fund managers are increasingly concerned that asset values are overheated.
On the face of things, something's amiss here ..... the VIX is seen as a highly sophisticated measure of assessing market sentiment that shows volatility, or nervousness if you like, trading at close to 24yr lows. Yet if fund managers are really as worried as they profess to be then surely they would be insuring against significant market reversals by purchasing options, forcing up the price of those options which would in turn and by definition would drive the VIX higher. What's going on ?
The possible explanation offered by Mr Johnson is that market bears may find themselves with more to worry about than just the lack of concern over stretched market valuations. They may have to face the fact that the VIX, which they adore with a passion and study in minute detail, may in fact have lost its usefulness as a meaningful indicator ..... cue : wailing and gnashing of teeth.
Of course, there is another possibility ..... that the stratospheric asset valuations and plunging levels of volatility are indeed a toxic combination signalling huge complacency, as up to now most of us have been taught to believe. If that's the case, something very nasty could well be around the corner, and not too many will be prepared for it.
Have a nice day .......