Something is off with one measure of volatility on Wall Street.
Goldman analysts Rocky Fishman and John Marshall said that the VIX, which uses options bets on the S&P 500 to reflect expected volatility over the coming 30 days, has been hovering at or below 13, marking its lowest level since around January (though it is tipping up in Monday trade). Its current level takes the gauge of implied volatility, which tends to rise when stocks fall and vice versa, well below its historic average at about 19.5 since the fear index ripped higher in February.
The VIX’s surge about three months ago ushered in an abrupt end to a protracted period of calm that had persisted among a series of repeated records for the S&P 500, the Dow Jones Industrial Average
and the Nasdaq Composite Index
in 2017 and the first month of 2018.
In a Friday note, Fishman and Marshall wrote that “there is a mismatch between how little SPX options cost (June straddle with over five weeks to maturity costs 3%) and how much the SPX has been moving (3.5% rally over the past five trading days). The VIX is in the 13’s, yet economic data are consistent with a VIX over 15, and its normal relationship with realized volatility would put it above 18.”
Goldman argues that the 5-day intraday swings of the S&P 500 have been out of whack with the price of the cost of a one-month straddle on the index. A straddle is an options bet that allows an investor to profit from a sharp move in an asset, but without wagering on the specific direction of that expected move. In other words, it is an inherent bet on volatility. A straddle can be structured by buying a put option, which confers the owner the right but not the obligation to sell an asset at a given time and price, and a call option, which offers the comparable right to buy an underlying asset, at the same expiration date and strike price.
The chart below illustrates the average five-day trading range for the S&P compared against the price of a one-month straddle over the past 10 years, excluding periods when the VIX already was well above its historic average at 25 (darker dots are more recent):
In the research note, Fishman and Marshall also measure the difference between the VIX and realized volatility, and conclude that the volatility index is low compared with the actual level of volatility in the market.
Moreover, although this disconnect appears to be happening with other indexes across the globe, it appears to be prominent in the S&P 500 and the Nasdaq, they said (see chart below):
Goldman’s analysis comes amid questions about the reliability of Cboe Global Markets Inc.’s
widely used VIX stock-market volatility gauge following the February spike and the subsequent demise of products linked to the index. Trading in VIX-related products, specifically those that allowed investors to bet on a continued decline in volatility, is widely thought to have helped exacerbate the February stock-market selloff.
The Wall Street Journal recently reported that the number of VIX futures contracts outstanding has declined precipitously since early February. That is despite what has been perceived as a pickup in volatility, as Goldman notes. The Journal reported that average daily volumes “slumped in April to the lowest level in more than a year, even as trading of futures and options in other markets rose.”
What’s more, regulators including the Commodity Futures Trading Commission, the Securities and Exchange Commission and Financial Industry Regulatory Authority all have opened investigations into VIX trading, seeking evidence of alleged manipulation.
A call to a spokeswoman at Cboe wasn’t immediately returned.