Courtesy of Surly Trader
It is pretty easy to say that on a quiet trading day a week before Christmas (S&P flat at a +.08%), the big news was the 10% decline in the VIX without any relevant news. Maybe the VIX thought the passage of the tax extension was phenomenally good for lower volatility going forward, but I highly doubt it. I received some interesting speculation from some investment banks, but nothing noteworthy. One thought it was a lack of gamma hedging after option expiration and another thought that implied was finally compressing towards realized. I highly doubt either of them. If I remember correctly, I asked the same questions back in April and then the VIX quickly shot up to 40%. Amnesia is a common market and investment bank trait.
Why collapse today?
Because the VIX and the front part of the VIX futures curve have fallen off, the VIX futures curve has a record steepness to it:
Nearly 10 vol points between the VIX and the furthest future?!
There are a few ways (and many iterations) to play this vol market in anticipation of a future spike in vol:
- Buy the short end of the VIX futures curve or the ETF VXX
- Buy the front part of the futures curve and sell the back half (buy Jan and sell a few Jun or Jul 2011)
- Buy puts/calls one month out at low implied volatility, delta hedge if needed
Maybe volatility is really coming down to “normal” levels, but I really get suspicious when reversion to the mean happens a bit too quickly for my comfort.
