by Chris Black
The first half of the year has been marked with an unusually low-volatility environment (t.me/DTpapers/99), reflected in and likely contributing to the equity rally from outset of the year.
Rallies in meme stocks, bitcoin, stocks, and home prices: Market action doesn’t look like this when money is tight. It looks like this when the Fed is either behind the curve or actively stimulating, the latter of which is not happening.
The VIX is a volatility index derived from (www.ipam.ucla.edu/research-articles/identifying-links-between-the-sp500-and-vix-derivatives/) S&P 500 options for the 30 days following the measurement date, with the price of each option representing the market’s expectation of 30-day forward-looking volatility.
The resulting VIX index formulation provides a measure of expected market volatility on which expectations of further stock market volatility in the near future might be based.
Volatility has historically been used to gauge market sentiment, and in particular the degree of fear among market participants, where high volatility = high fear.
Recent activity in ultra-short term option (0DTE) trading has skewed the VIX lower than it otherwise would (academysecurities.com/wp-content/uploads/Why-Do-I-Keep-Thinking-0DTE-stands-for-Zero-Dark-Thirty.pdf), prompting exchanges to create a “1-day VIX (www.cboe.com/us/indices/dashboard/vix1d/)” (a one-day forward projection of volatility, versus the VIX’s 30-day projection).
How low can it go?
Volatility-control funds (assets.milliman.com/ektron/Vol_Control_Funds.pdf) are gunning (quantpedia.com/an-introduction-to-volatility-targeting/) for VIX to get crushed down to 9 before they turn to sell equities (Nomura: “we remain SHORT VIX/LONG EQUITIES to the 9-handle” (t.me/DTpapers/100)).
Seasonal factors noted by Goldman and BofA (t.me/DTpapers/98) point to July as a potential bottom in the VIX. But as the adage goes, the market can remain irrational for longer than traders can remain solvent.
TL;DR: The VIX may have to puke down into the single digits before the rally ends.
[BofA VIX note (t.me/DTpapers/98)]
[SocGen (t.me/DTpapers/99)]
[Nomura (t.me/DTpapers/100)]