Week in Volatility

After a sharp decline last week, VIX traded in a 15.50-16.50 range, surprisingly rising on Thursday , which was the last trading day of the week. Given that many exchanges around the world will be closed tomorrow, and light trading around the New Year I expect the spot volatility indexes to remain low, while the term structure of futures to be high. This all should put some pressure on VXX, however I don't have a forecast. My forecast for the VIX to be in little higher in 16 - 17 range.

For January expiration my forecast is for 17.66 +/- 3.85 vs market forecast (based on futures and options implied volatility) of 19.80 +/- 4.53.

Week in Volatility

While stock and volatility indexes remained choppy most of the week, VIX took a beating on Friday, declining from already technical low of 17.50 to 16.00. I am sure that part of the decline is to be explained by lowered trading activity around holidays and non-trading days (VIX is calculated in calendar days, making it low biased) however that does not explain the whole story - for example VSTOXX that has similar calculation and holidays actually rose on Friday. So I will do some cross-asset comparison: GVZ - gold volatility also dropped on Friday to a new low, MOVE index that is tracking interest rate volatility is at 1-year high, JPMVXYG7 index that tracks implied volatility of G7 currency options is somewhere in between its 1-year high and low. My forecasts (and my trading positions) are for VIX to increase in price.

VIX Falls

As I'm writing this VIX is trading at ~15.60, very close to it annual low of 15.23 back in April. This level is obviously significantly below what I expect a month ago, but also lower than investor expectations. The front month futures expiring on Wed, Dec 22 that have only 2 full trading days until expiration are still relatively juicy at 17.30! Of course the big question on everyone's mind is what is next for the market and for the VIX. While the future is uncertain, I think that VIX has entered a low-volatility regime (see my post here). I think economic uncertainty will not allow long-term VIX futures to fall much lower (back months are about 25) , which means that term structure premium is likely to remain high. If I'm correct in my hypothesis, we can see a steady decline in VXX due to increased rolling costs. Good luck traders, hope everyone has a good expiration!

VSXX Disappoints European Investors

I have written before about VSXX - an ETF that tracks pan-european VSTOXX volatility index, European equivalent of VXX. In that post I described how VSXX performance may be different, because of the flatter term structure of VSTOXX volatility futures, that will translate into lower rolling costs, and better performance for VSXX investors, at least compared with VXX. I also noted that traders may take advantage of this difference in a relative value trade. When I wrote the post, VSXX was trading for only two months, however now after seven month of trading it is becoming clear that my investment hypothesis not deliver, and VSTOXX futures markets became more economically efficient.

Here's the chart of what happened: VSXX originally listed at around the same Euro value as the index, however in the last few weeks VSXX is about 70% of VSTOXX index.



If you looked at the relative plots of VIX and VSTOXX with their futures indexes (on which ETFs are based) it is clear that historically VSTOXX futures index did much better job in tracking index levels than the VIX futures index. To understand the dynamics, I have performed the following two regressions:

return on SPVIXSTR ~ α + β * return on VIX, and
return on VST1MT ~ α + β * return on VSTOXX.

Using the data for the last five years, in the first case α = -0.0016174 (t=-3.2335) α * 252 = -40% per year negative "premium" for the VIX futures index. In the second case α = -0.00021095 (t= -0.30876, intercept not statistically significant) α * 252 = -5% per year negative "premium" for the VSTOXX futures index.

However when I used data for the last half year - approximately since VSXX came into existence, intercept values became much closer to each other, at -0.006422 -0.0047229 for VIX and VSTOXX respectively. These numbers by themselves imply a very negative risk premium, they are at least the same order of magnitude, as opposed to alphas from the 5-year regressions.

It seems that there is an equal demand now in Europe for volatility protection, which brought returns on the futures indexes in line with each other. In fact VSXX and VXX followed very similar paths (normalized returns in local currencies)

In conclusion: what was hoped to be a unique investment opportunity for European investors seized to exist. Once a trading instrument is in the market traders work quickly to make profits and eliminate inefficiencies.

Russian Volatility Index

It is official, yesterday RTS announced (eng, rus) that they will start disseminating the first "official" volatility index based on the Russian options market.

I blogged earlier about Russian VIX here, however at this time ОТКРЫТИЕ removed previous links to the construction of the volatility index, and I could not find any details on the RTS website. I assume that either way the exact methodology will feature two modifications to the VIX algorithm, namely parametric interpolation of the volatility skew to deal with relatively small liquidity in the market, and nonlinear weighting of the months, because expirations are sparse, and do not always bracket 30-day maturity.

RTS stated that they will start disseminating the index on Dec 7th. Bloomberg ticker for the index is RTSVX.