Commodity Volatility Indexes

One of the most exciting recent developments in volatility space was the launch of two commodity volatility indexes on CME - one based on NYMEX Crude Oil contract, and another on COMEX Gold. While there has been no volume in these products, I hope that will change when CME will list options before the end of the year. Meanwhile I started researching existing commodity volatility indexes. In the summer of 2008 CBOE launched two indexes: OVX based on USO options and GVZ based on GLD options, both using the same methodology as the VIX. In the October of this year, CME and CBOE announced creation of another two parallel indexes on crude oil and gold volatility, but based on CME contracts. Also Johannesburg Stock Exchange calculates SAVI White Maize - a 3 months volatility index for white maize, which (to a city person like myself) is some type of corn. Exchange summary is available here. At this point I believe these three are the only commodity products that have volatility indexes. If you know of any others, please send me an email. Since now there are many more indexes available for comparison, I decided to draw some charts. Below is the overlapping history of OVX index (based on USO) and OIV (based on CL) . As you can see that two indexes are comparable. What is interesting (and I have double-checked the data) is that it appears that OVX was leading OIV for about a year in the plot, until late 2009. In the past 12 months the apparent lead disappears, and indexes move more or less in tandem. Again, let me emphasize that I have not performed statistical tests to determine any lead / lag relationship; the statements above are based purely on eyeballing the charts. Oil volatility seems to be only slightly related to equity vol, which makes sense since the two are driven by different fundamentals. Gold volatility however, driven by dollar / inflation risks, does track VIX more closely.
I could not obtain historical data for GVX index from CME website, but would like to conduct a more thorough analysis of gold-equity volatility once data becomes available.
See more commodity volatility indexes here.

VIX Forecast

VIX settled Wednesday morning at 22.21, up 0.80 from last expiration, but it was a wild ride! My biggest bet for the past expiration was for VIX to finish below 20, which was working out fine for me right before last Friday. I finally got my code in place and ran expiration plots for december: the expected value for the VIX 20.57 with volatility (in $, not %) of 5.26. Also, I included probabilities of VIX expiring at a particular range. For the trading purposes it seems that the market is ambivalent between low-volatility regime and middle-volatility regime, and honestly I don't have a good gameplan yet. Good luck, traders, and hedge your deltas!

22-DEC-2010 probability of VIX from 10 to 15 is 4%

22-DEC-2010 probability of VIX from 15 to 20 is 54%

22-DEC-2010 probability of VIX from 20 to 25 is 30%

22-DEC-2010 probability of VIX from 25 to 30 is 7%

22-DEC-2010 probability of VIX from 30 to 35 is 3%

22-DEC-2010 probability of VIX from 35 to 40 is 1%

22-DEC-2010 probability of VIX from 40 to 45 is 1%

22-DEC-2010 probability of VIX from 45 to 50 is 1%

22-DEC-2010 probability of VIX from 50 to 55 is 0%

22-DEC-2010 probability of VIX from 55 to 60 is 0%

22-DEC-2010 probability of VIX from 60 to 65 is 0%

22-DEC-2010 probability of VIX from 65 to 70 is 0%

22-DEC-2010 probability of VIX from 70 to 75 is 0%

More VIX stuff from Jeremy Wien

I already wrote here about 2 most excellent presentations Jeremy Wien did on the VIX, but earlier today I found (googling) another article that I have never read before where he gives rules for trading VIX and VIX options.

1. There's a lot of "air" once we move out of the perceived range of the VIX
2. The rules of market liquidity in crises apply to VIX ten-fold
3. Never sell a VIX call below .25 unless it is protected by something
4. You must manage your VIX positions at least semi-actively (even/especially the ones that are in place as hedges)
5. For true CRASH protection, there is not a better product to own than a low-delta VIX call

While not as detailed as his other 2 articles, there is a lot of helpful advice. Enjoy!

Week in Volatility

S&P and Eurostoxx fell about 2% this week, however Friday's action really pushed VIX futures higher. VSTOXX futures ended the week only slightly higher - mostly because of the time difference having closed on Friday while VIX continued to rise, and I fully expect VSTOXX futures to open lower on Monday (by about a point) to make up the difference.

Overall this week's action surprised me. I was positioning my portfolio to profit from further fall in the VIX, where my max profit zone is from about 18 to 20 in the front month, however given Friday action (VIX high at > 21) with just 2 full trading days to go before expiration seems like a very uncertain proposition.

While I thought that the market decided that it is the time for low volatility regime, we're still probably in the mid vol levels - and can easily see VIX push higher given a catalyst.

Canadian VIX - VIXC

Few weeks ago Montreal Exchange changed the methodology of its volatility index. The old index, MVX was constructed in the same way as the VXO - using implied volatility of ATM options, while the new index VIXC (Bloomberg symbol VIXC:IND) uses the same methodology as the VIX. Here is a presentation on the index construction. Unfortunately the old index was completely discontinued, while the new index has only one year of history. For my research purposes I combined the two, averaging closing values on the overlapping period. Exchange data here, and you can download the combined data here.

Below is the chart of the combined history MVX-VIXC vs VIX.

Confused by VIX / SPX correlation? You are not the only one!

This morning I came across this gem on FT blog. Based on her statistical and technical analysis (see the chart attached to the post) the author writes that recently correlation between SPX and VIX has been positive, and predicts that it needs to return to the norm. The problem is that the author has got it all wrong, confusing price correlation and return correlation.

If we look at some short time periods, it is not unusual to observe VIX prices to look like a mirror image of SPX prices, just like in the chart on FT website. This pattern however is not robust - if we look at a scatterplot of SPX prices vs VIX prices over the last 20 years, it is clear that there is no correlation. It is also intuitive - S&P moves around all over the place, while VIX stays most of the time in a range.


Where correlation is robust is in returns - percent changes (daily, weekly, etc.) The scatterplot of daily returns for the last 20 years clearly shows strong negative correlation (-0.69) in the data.

The same pattern exists for weekly and monthly returns (I created the plots using non-overlapping returns)

From what I see in the data any correlation between SPX and VIX price levels is mostly spurious and coincidental.

What is equally puzzling is the authors' claim that correlation turned positive since October 22nd of this year. There's been only 8 trading days, and hardly any statistic should be calculated on only 8 observations, especially such a "noisy" one as correlation. Even if I were to agree with Ms Brooks methodology, the correlation observed is 0.35 +/- 0.37 (MSE using 10K bootstrap simulations) i.e. the real correlation cannot be reliably estimated based on such a short sample. The last plot is the histogram of correlation coefficient.

Two points in conclusion:

1 - there is no stable correlation between SPX and VIX price levels, but there is a stable robust correlation between SPX returns and VIX returns on different time horizons.

2 - need more than 8 days of data to create reliable statistics.

MOVE Index, Part 2

My last post was about predicting VIX index using MOVE index where I posted a basic model for VIX fair value. MOVE closed last week at 99.80 (Bloomberg) , implying VIX price of 20.98. Of course to use the model one needs to investigate the average error. To do that I used 10K bootstrap regressions to figure out mean absolute error of 4.72(histogram below). While not amazingly accurate, VIX fair value model is good enough as a basic cheap/expensive indicator. Since the current VIX value is well within the error of the forecast, it is clear that equity implied volatility is in line with the Treasury markets.