MOVE index (Merrill Lynch Option Volatility Estimate) was developed by Merrill Lynch to measure implied volatility of US Treasury markets. ML became a part of Bank of America in 2008, and then indexes were sold to ICE in 2019, so now the index is called "ICE BofAML MOVE Index"
The index is a yield-curve weighted average of normalized implied volatility of 30-day options. The index has been in existence for several years now, however it is seldom discussed, either in itself, or in relationship to the VIX. What I am interested in is if volatility in the treasury market can be used to predict SPX returns.
VIX and MOVE are highly correlated - this is obvious from the time series charts.
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While both indexes are constructed with 30-day volatility, fixed-income markets are believed to be more long-term looking, and the ratio of two indexes indicates the difference (in colloquial, not mathematical sense) in riskiness of equities to more long-terms focused fixed income markets. If the VIX is high relative to MOVE, it can be interpreted as equities are perceived to be relatively risky, but overall economy is ok. This is where we would expect SPX to outperform.
The low ratio indicates that equities are complacent, and fix-income markets are worried. This is when the best to stay away from the markets.
With this in mind I created 2 simple strategies with daily re-balancing - hold SPX is VIX/MOVE > historical median, and a reverse strategy, holding SPX when index ratio is below its historical median.
VIX/MOVE ratio is an interesting and un-correlated indicator to keep an eye on.
"With this in mind I created 2 simple strategies with daily re-balancing - hold SPX is VIX/MOVE > historical median, and a reverse strategy, holding SPX when index ratio is below its historical median." - this reads to me as hold SPX regardless of VIX/MOVE ratio so is this statement correct?
ReplyDeleteI will also link the spreadsheet in the new blogpost
DeleteThank you - you're right, the way I wrote it was ambiguous. I meant that one strategy (yellow) is long SPX when ratio is high, and flat otherwise. The second strategy (red) does the opposite - long SPX when ratio is low and flat otherwise.
ReplyDelete