Octobers are supposed to be the scary, and not only because of Halloween. Market observers like to point out how much more volatile October is relative to other months. Not so in 2016 as Goldman notes this was the 4th lowest average VIX since records began. However, the last few days have seen hedgers extremely active ahead of next week's election (despite one of the lowest levels of S&P 500 realized volatility recorded).
Via Goldman Sachs,
Typical VIX level on election day = 17.6
VIX in-line with past elections but the vol risk premium is high
The VIX closed on Monday October 31 at 17.1, up four points (+31%) over the last week. The VIX has a history back to 1990, which covers six U.S. presidential elections. Exhibit 1 shows the typical VIX level heading into election day and compares that with the recent VIX pattern. The median closing VIX level on election day has been 17.6 back to 1992. By those numbers, an argument could be made that the VIX had been traveling 3-4 points low relative to past election patterns before catching up a bit over the past few days.
A VIX a bit above 17 would place it in-line with its typical level of 17.6 ahead of past elections.
Warning label: it is hard to make a high conviction statement with six data points, especially when two of the periods occurred during the tech bubble in 2000 and the financial crisis in 2008.
Bottom line: While the VIX is now more in-line with its typical pre-election pattern, the VIX has been rising despite one of the lowest levels of S&P 500 realized volatility recorded for an October. In short, hedging demand has been rising even though the market really hasn’t moved that much.
October 2016: One of the lowest volatility Octobers on record at 6.6
October not so scary in 2016 Octobers are supposed to be the scary, and not only because of Halloween. Market observers like to point out how much more volatile October is relative to other months. Not so in 2016.
Two pieces of post-Halloween vol candy:
- S&P 500 realized volatility during the calendar month of October was 6.6, the lowest for an October in 23 years (1993).
- VIX levels have been around since 1990. The average VIX level of 14.6 in October ranked as the 4th lowest for the calendar month of October back to 1990.
Bottom Line: The fact that investors are purchasing broad based macro hedges ahead of the election, even though the market isn’t moving, is causing a large spread between implied volatility (the market price of option hedges) and realized volatility (how much the market is actually moving).
The VIX is trading at 2.6x its normal spread to realized volatility
The volatility risk premium is elevated ahead of the election Investors often buy options to hedge equity portfolios. But that doesn’t come for free. The VIX typically trades at a premium to realized market volatility to compensate vol sellers. An analysis of the VIX – SPX 1m realized volatility spread can offer clues as to how much risk premium the options market is baking in, or how complacent the market really is. A VIX on the rise during a period of muted realized volatility has led to wide implied versus realized volatility spreads. In English, the VIX is trading high relative to recent market moves.
S&P 500 10-day and 1m trailing realized volatility measures stood at 5.4 and 6.6 as of the end of October. That puts the VIX – 1m realized volatility spread at 10.5 vol points (17.1 vs. 6.6). That is a 95th percentile ranking back to 1990 and 2.6x higher than the average spread of 4.1 points back to 1990.
Bottom Line: Goldman Sachs economist Alec Phillips thinks the likelihood of a Brexitstyle surprise by the Trump campaign is unlikely given the consistency and magnitude of the Clinton lead across many polls. If that thesis holds true, we would expect the VIX to move lower and the S&P 500 higher post-election as uncertainty declines. A VIX collapse could happen quickly given the current wide dislocation between implied and realized volatility.
via http://ift.tt/2dZrKok Tyler Durden