What's Behind the Calm VIX?

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Bloomberg Mar 28 02:34 · 11.7k Views

Mandy Xu, head of derivatives market intelligence at Cboe Global Markets, examines the factors fueling the calmest US stock market since 2018.

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Transcript

  • 00:00 The JP Morgan view, is that OK, you have this big boom in these options selling ETF.
  • 00:05 I believe
  • 00:06 AUM is over $60 billion at this point.
  • 00:09 They think that's suppressing volatility.
  • 00:11 I know you take the other side of that exactly.
  • 00:13 So I think the key thing to keep in mind here is that correlation does not mean causation, right?
  • 00:18 Just because two things have been happening at the same time, the AUM and these funds have been growing at the same time as the VIX has been falling, does not, does not mean that one is leading to the other.
  • 00:27 And to really kind of dig down into the impact, what you really want to see is the impact on the volatility surface.
  • 00:33 Now if these funds were having a disproportionate impact on the volatility surface, you would expect two things.
  • 00:39 One, you would expect the volatility risk premium to start to shrink and the 2nd is you would expect the price out of the money call options to actually decline relative to at the money call options given that majority of these funds are overwriting or selling calls.
  • 00:52 And in fact on both fronts we're actually seeing the opposite.
  • 00:55 The volatility risk premium actually grown over the past year
  • 00:58 and also
  • 00:59 the out of the money call options have actually been historically rich
  • 01:02 relative to the at the money.
  • 01:04 So if you're looking for you know the dominant force in the derivatives market right now, it's not the overriders, it's not the call sellers, it's actually the call buyers that has been driving some of the dislocations that we're seeing in the volatility surface.
  • 01:16 So in terms of the idea that the VIX signals a solid economy and not some
  • 01:20 some other situation, you've also written recently that Immaculate disinflation that many economists warned was impossible turned out to be very much possible.
  • 01:28 What does this mean for the volatility picture
  • 01:30 and stocks and investors who may not be
  • 01:33 so happy or actually may be reluctant to buy after such a robust frothy rally.
  • 01:38 Yeah, great Abigail, that's a great point you bring up.
  • 01:40 So you know when I get asked questions like why is the VIX so low, right to me it really
  • 01:44 I have to point to the macro picture because low volatility is not something that we're just seeing in the equity market, but we're actually observing across all asset classes credit volatility, 10 year low rates volatility also off the highs that we saw over the past year, FX volatility at a low commodity volatility.
  • 02:01 I can go on right.
  • 02:01 So that to me again signals that the reason why volatility is so low
  • 02:05 is because of this
  • 02:07 positive turn in the
  • 02:08 outlook, right.
  • 02:09 We went from fearing recession to now expecting a soft landing.
  • 02:13 So to me, you know for investors who at this point in the market where they are, we're at, you know all time highs.
  • 02:18 You know, I think using options to manage your risk whether it's the upside or the downside presents a great opportunity given you know the low levels that we're seeing in terms of of volatility.
  • 02:27 Now the VIX may be super low, but that's so much for single stock volatility.
  • 02:31 What does this mean?
  • 02:32 Yeah.
  • 02:32 So
  • 02:33 that's a great point.
  • 02:34 We are seeing actually quite a robust volatility underneath the index surface.
  • 02:39 So single stock volatility is actually
  • 02:41 very, very high relative to index volatility.
  • 02:43 So you see Vicks at you know I think right now around 13
  • 02:46 average single stock volatility in the S&P
  • 02:49 trading around 30, right and that spread is near all time highs.
  • 02:53 That really tells you that
  • 02:54 like the,
  • 02:55 the main stories right now going on the equity market, it's it's about tech, right?
  • 02:59 It's about AI.
  • 03:00 It's about a lot of these idiosyncratic risks
  • 03:03 and that's why you're seeing the elevated volatility
  • 03:05 in those space.
  • 03:07 So you mentioned that spread is the highest and it's been for a long time.
  • 03:10 If we look at past periods when you had that
  • 03:12 dislocation, does that portend anything about how that could translate into
  • 03:17 volatility at the broad index level?
  • 03:19 It's not necessarily I would say a leading indicator one way or the other, but certainly levels have gotten very extreme.
  • 03:25 So the other, the flip side of very high single stock volatility, high dispersion is just saying that correlation in the market right now is extremely low, right.
  • 03:33 Investors are still expecting this year to be
  • 03:36 very much like last year, a very much a year about
  • 03:39 stock selection, there a
  • 03:41 year about sector rotation, you know sectors
  • 03:44 know which sectors outperform relative to the other.
  • 03:46 There's very little macro risk being priced into
  • 03:49 the VIX being priced into the index volatility market.
  • 03:52 So you know,
  • 03:53 think about the other side of this is that, you know if we're wrong, right, if this
  • 03:57 optimistic outlook on the economy is wrong and we do really
  • 04:00 end up, you know, going to recession or recession risk start to
  • 04:03 rising, then you could see a pretty
  • 04:05 dramatic repricing in the VIX and the index volatility of that correlation level really start to pick up.
  • 04:11 It hasn't yet, but that's something that we're definitely keeping an eye on.
  • 04:14 Yeah.
  • 04:14 So it sounds like you're not all that concerned, but you're keeping an eye on, are you seeing any signs in the world of derivatives that something along these lines could happen that just like risk off or a correction or even a bear market out of out of nowhere.
  • 04:25 So that happens.
  • 04:26 We are not seeing much demand for, I would say the vanilla portfolio hedges like people, you know, looking at say protecting a 5 to 10%
  • 04:35 more modest drawdown.
  • 04:36 I think the view there from a lot of investors that we speak to is that you know there's still a lot of money on the sidelines.
  • 04:41 There's actually be a good buying opportunity.
  • 04:43 But where we are seeing elevated demand for hedges is actually Vicks options.
  • 04:47 So protecting not against a small correction but rather a crash or
  • 04:51 you know, Black Swan type of event.
  • 04:53 So
  • 04:53 Vicks call volumes this year is actually higher than last year.
  • 04:56 Last year was already a record year.
  • 04:59 So we're still seeing a.
  • 05:00 A lot of demand for that tail risk protection,
  • 05:02 even though I would say people have gotten
  • 05:04 a lot more constructive in terms of, you know, what would happen on a modest drawback.
  • 05:08 When's the last time that you saw that and did it prove true in terms of some sort of a Black Swan or mini Black Swan event.
  • 05:14 So the last time we've seen this kind of elevated of the demand for VIX options, we should go all the way back to 2017 which if you recall was a record low volatility year.
  • 05:23 So that was the year and also
  • 05:25 in addition there was you know obviously the inverse VIX ET PS that were getting a lot of attention.
  • 05:30 I wouldn't say we're in the similar setup now.
  • 05:32 You know even though there's been this growth in the short volatility trade, the call overriding the put underwriting trades, there's no embedded leverage in these.
  • 05:39 So the people always ask, you know, is this a potential catalyst for of all mageddon?
  • 05:44 My view is no, just because these products are not levered
  • 05:47 and they actually outperform these strategies, outperform on a market pullback.