Investors who bought calls in July on the Cboe Volatility Index — better known as Wall Street’s “fear gauge,” or simply “the VIX” — to help offset potential losses in their equity portfolios this summer have found they didn’t need the protection anyway.
But demand for VIX
call options still remained elevated as the call-put ratio rose to nearly 4 earlier this month, its highest level in 2½ years, according to Cboe data, as investors scrambled to protect themselves from the threat of further losses, after U.S. stocks tumbled to their lowest levels since late 2020.
However, this week, a dour stretch for stocks shifted to something more upbeat as equities embarked on their latest leg higher after Wednesday’s meeting of the Federal Reserve. The S&P 500 has rallied more than 5% since the market opened on Wednesday, as equity bulls were emboldened by the Fed’s latest 75 basis point interest rate hike and Chairman Jerome Powell’s comments during the press conference that followed, including his belief that the U.S. economy is not in a recession.
As a result, the VIX has plunged to its lowest level since April, and the VVIX, which measures the implied volatility of the VIX index, has fallen to a three-year low below 80, according to FactSet data. The level of the VVIX is important to investors and traders because the implied volatility of the VIX is the main factor used to price VIX-based options. With implied volatility so low, the price of one-month out-of-the-money VIX calls has dropped to the lowest level since the summer of 2019, according to FactSet.
That might make volatility options look attractive to some investors, perhaps to pension funds or other large real-money players looking to cheaply hedge their portfolios. But Danny Kirsch, head of the options desk at Piper Sandler & Co, said there are good reasons why VIX options are so cheap right now.
“The reason VIX calls are so cheap is because they haven’t been working,” Kirsch said.
On Friday, the VIX went as low as 21.31, according to FactSet data. That’s the lowest level since April 21. But even when volatility was on the rise earlier this year as stocks sold off sharply, the VIX never made it to highs reached during other recent market ructions.
For example, the VIX soared to 85 during the COVID-inspired selloff in March 2020. By comparison, the VIX has yet to surmount the 40 level at any point during 2022, even as U.S. stocks endured their worst first half in more than 50 years.
The reasons why the long-volatility trade hasn’t been as useful this time around are myriad and complex, according to Kirsch. One important factor is related to the demise of short-volatility exchange-traded notes like the VelocityShares Daily 2x VIX Short-Term ETN
which was delisted by Credit Suisse back in 2020, although it still trades over the counter.
“You don’t have these massive short tails that need to be covered,” Kirsch said, explaining that because there are few short-volatility products, there’s less demand for VIX calls when markets turn volatile and holders of short-volatility products need to cover their losses or hedge their exposure.
Looking ahead, perhaps it makes sense that unrealized volatility — which is what the VIX measures, since the index is based on the prices of near-term options on the S&P 500 — has been so low.
As Kirsch pointed out, a large amount of “event risk” has just been cleared from the market’s calendar. For example, investors received a reading on second-quarter U.S. GDP on Thursday, and the busiest week for S&P 500 corporate earnings this quarter ended on Friday.
Aside from the Federal Reserve’s summer sojourn to Jackson Hole, Wyo., investors won’t hear from the Fed again until its September policy meeting, which may be the next opportunity for the central bank to raise interest rates.
“We’re in the middle of the summer, there are fewer obvious catalysts, there isn’t another Fed meeting until September,” Kirsch said.
U.S. stocks advanced for a third-straight day on Friday, with the S&P 500 up 1.4% to 4,130.29. The Nasdaq Composite
gained 1.9% to 12,390.69, while the Dow Jones Industrial Average
rose 1% to 32,845.13.