The VIX and one-month realized volatility have hit one-year lows, indicating bullish implications in the short term for markets. Lower realized volatility suggests lower future volatility, which can create positive returns.
The spread between the VIX and one-month realized volatility shows positive returns for periods when realized volatility is 16 or less. However, there are nasty tails in the distribution of returns, which can affect equity markets.
Nonetheless, lower volatility can trigger CTAs to allocate more to buying equities, while options dealers can buy back hedges, providing a tailwind for equities.
Video Transcript
00:00
the vix just hit one year lows and one month realized volatility also hit at or near one-year lows so we’re going to talk about what that means for you and we think it has bullish implications in the short term for markets so in blue is one month realized volatility so that tells us how much the market has been
00:15
moving on a rolling basis over the last one month now implied volatility we’re using the vix as a proxy the vix is essentially a measurement of 30-day implied volatility in the SP wire SPX and so the two are somewhat comparable because we’re looking at a one month trailing window and comparing that to a one month
00:32
forward looking metric right to see okay given the fact that Traders see less volatility over the last one month what does that mean for volatility looking forward and in general what we should have here is lower realized volatility should mean lower future volatility right because what’s our best proxy for
00:49
what the market May do in the future well it’s what the market has been doing in the recent past and so what you see here is indeed really at the end of March and into most of April realized volatility has come down sharply that tells us that market movement by and large has been really shrinking quite a
01:05
bit and again you can see we’re at Lowe’s that really rival that of 2020 2021 where there’s just a very bullish market right and we were constantly making new highs now what that is serving to do is drag down the vix and drag down implied volatility and that of course crushes put options in particular and we think that’s one of
01:22
the reasons that this can help to create positive returns but narratives aside let’s actually look at some of what the returns are so to break this down what we did here is we compared the spread between the vix and one month realized volatility and that is what’s on the y-axis and then on the x-axis here’s the five day
01:39
forward Return of the spider so given what the vix and realized volatility spread is today what did the spiders do five days out in time now what you can see here the first thing many of you will pick up on are these really big positive returns here on the lower right quadrant now what this is is typically
01:55
in terms of large crises like in February of 2020 or the bank crisis even recently here in March the vix will Spike right and will have a very violent Spike and then the equity Market will sell off and generally the FED comes out and and says hey we got your back here we’re going to provide liquidity or
02:12
backstop something and then suddenly the vix collapses right Traders sell implied volatility because they know that the risks or they believe I should say that the wrists have been addressed and that should provide for a bounce in the markets so the vix will solve very sharply and the market will tend to
02:28
Rally very sharply at that at that point however realized wall because it’s this fixed window it takes several days right or weeks for those High volatility points to roll out of the calculation right to roll out of that one month trailing return and so what you get is the vix will suddenly collapse right and
02:45
realize Vol is held high so if we look at some of those periods obviously the covid crashes the Marquee one here where you can see the FED backstop markets the vix gets crushed but again that realized volatility metric takes a little bit of time to come down right so again the idea is that look yes there was massive
03:02
volatility in the past but we now have a great reason to to expect that volatility comes down in the future if the fed backstops us off of risks so those are when the most positive returns happen but what it Returns what do returns look like for periods like now and for that those are the orange dots
03:17
so we look at one month realized volatility right now it’s about 16 and so we did is we looked at periods where realized ball was 16 or less and those are the orange dots and as you can see that the the returns are typically positive there to the right here there are a few nasty Tails which we’re going to talk about in a second
03:36
but in general the returns are positive and we think the returns are positive because lower volatility is often a signal for ctas like Vault targeting strategies they may decide to allocate more to buying equities if volatility is coming down so you have some of those triggers and then we also think in
03:51
general that if you’re a market maker or a options dealer at a bank Etc anytime puts are losing a lot of value if you’re short those puts you can buy back Hedges as a result right so if if vix is coming down vix Futures are coming down if puts are losing value generally we think that is a Tailwind for equities and that
04:08
helps to boost equities and the returns seem to support that thesis now if we look at the distribution of these returns what you can see is that indeed most of the time we’re seeing a zero to one percent positive return you can see that there’s certainly a skew to these returns and that in general we’re
04:24
positive but there are these very nasty tails now these tails are the result of times when markets are very calm and then suddenly you get hit over the head with the risk and because implied volatility is so low and realize volatility is so low it pops as Traders suddenly shift from risk on right to
04:42
risk off and that was most clear I think in February of 2020 where the world could kind of see the ramifications of covet and the virus picking up steam right in that unfortunate circumstances but the equity Market by and large through the first couple of weeks of the pandemic there in early February seemed
05:01
to shrug it off it didn’t really seem to matter and then we hit February Opex which is roughly the third February 21st roughly and then all sudden you know the market just Equity Market just went risk off and we just had some really really nasty returns and I think sometimes you may want to draw some interesting
05:18
parallels so that certainly we’re not in that same pandemic period of of extreme turmoil but right now the equity markets seem to be ignoring you know possible debt ceiling issues possible recession possible you know further Bank crises right those are kind of tomorrow’s problems or those problems are at least
05:34
a month away if not more it’s data dependent we’re not really sure and so in the very short term realize volatility is very low the vix keeps coming down and what we think is that is that’s going to give us a Tailwind through the start of May and again this is because as that realized Wall comes down we think that
05:50
it it provides a bullish Tailwind for Market some of you may refer to this as kind of a Vanna flow right where this vix coming down is telling us that those options are losing value volatility is coming lower and that can lead entities to have to buy stocks and equities and again this all works out very well until
06:07
you that kind of tailors pops up and one can’t help but Mark May optics for possible topping period as we move forward over what should be a continuation of a lower ball period so we hope this helps if you have any questions please leave them in the comment section below or hit us up on Twitter at SpotGamma
