My friend Bill brings up some very good points in the comments recently. Option volatility, most readily expressed by the VIX, is actually not high relative to actual market volatility.
The upper chart show 30 day implied vol. of the SPY in yellow, and 30 day Historical volatility in blue. And as you can see they have moved almost in lockstep.
But here’s the kicker, the IV anticipates 30 days ahead, while the HV tells you what happened 30 days behind. So in order to match up how a general option purchase did, you would have to mentally move the yellow one month, or box over to the right. In other words, let’s say you bought volatility in the form of 30 day options today. You’ll theoretically profit if the volatility of the actual market going forward 30 days is greater than the volatility you paid (pending specifics, I’m generalizing here). We don’t know how that will work out yet, but we do know with the offset that owning options at a low 20’s volatility worked stupendously well as actual realized volatility continues to climb.
Down below we show 10 day normalized historical volatility, a noisier but better measure for volatility in the here and now. And that has shot up above 60.
What’s striking is this is the mirror image to almost the entirety of 2005 and 2006. SPY volatility sat in the low teens and below, and even at those “bargain” prices, options were consistently overpriced relative to actual volatility. Which often was something like an 8 and below.
So yes, options were irrationally fearful at a 13 volatility in 2006, but not necessarily fearful enough at a 30 and even above in 2008. 48 probably another story, but time will tell
This post is banned for providing too much information to the common man.
lmao, i’ll simplify it to “yes options high, but market volatility extemely high”
Still not allowed. Normally they would be, but I will only accept “some things are high, other things are higher”
how about, “stock bad, options good”?
Don’t fight with the SEC, Adam. Next thing you know, they’ll be outlawing long puts and short calls. How dare you speculate AGAINST our companies!!! (Or they’ll just jack up the spreads even higher.)
I’m a big fan of focusing on magnitude of directional movement, mainly because I trade equities, trade infrequently and mechanically, and hold positions for weeks or months.
Adam, it is not so much that you jog the AV backwards vs jogging the IV forwards.
From a modeling perspective, you could “predict” a fair range for today’s VIX (which itself is a prediction of future volatility) by looking at recent ACTUAL volatility. This is a fancy way of saying that part of the VIX’s “prediction” of future volatility is just a reaction to recent events.
The other component of the VIX, the part that REALLY measures sentiment, is the difference or ratio between an expected VIX based on recent volatility (and/or a component of recent index price change), and the actual VIX.
If the actual VIX is much much higher than an expected VIX based on past events, then we really do have buyable fear – which implies a directional movement for equities, i.e. UP.
If the actual VIX is much much lower than an expected VIX based on past events, then we have a sell-able complacency and an expected move down for equities.
When the actual VIX is not too very far from what’s expected … like it is 80% of the time … I think this idea isn’t of much use for directional index trading and would (if I were solely using this idea to time the market) just hold whatever the last signal was.
I’ll defer on the very active options trading implications of the VIX to you and to Bill Luby at VIX and More.
lmao, even just talking about puts might get my on a no-fly zone.