Week in Volatility

Equity indexes were up this week with S&P up 2.7% and Stoxx up 1.6%. VIX index sank more than four points from 20 to just below 16. Long term futures declined by about 1.5, with the longest expiration now trading at 23.30. VStoxx fall was more modest, with long-term volatility still above 26%.

While uncertainly in Egypt may have been an excuse for volatility rise last week, we see that market discounted it as a non-event. Even now with more recent news about gas pipeline explosion, would probably not be a catalyst for higher volatility. Long-term futures tell us unambiguously that we're still in the low-volatility regime.

One of the reasons for such fall in volatility can be falling correlations. After the crisis in 2008 we've seen a spike in correlation among all asset classes, what became colloquially known as risk on / risk off. Lately that pattern started to wane. For example KCJ implied correlation index closed near a 6-month low (chart) Looking at historical charts of  ICJ, JCJ, KCJ it looks like implied correlation will likely not to go much lower, and that is probably going to have a negative effect on VIX skew.

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