Volatility Spiking?
No shortage of educated opinions on wtf is going on with the VIX. But here’s a fascinating one via Don Fishback. By one measure, we actually sit at 5.5 year highs.
What’s interesting is what things look like below the surface. We have implied volatility data on every stock going back to early-2000. We did a relatively simple calculation that took the average implied volatility of the at-the-money options for each of the S&P 500 constituent securities — sort of a VXO for each and every stock. We then calculated the unweighted average of the 500 individual implied volatilities to get the average implied volatility of the S&P 500 stocks. We call this ODDS SPXIV. I have plotted ODDS SPXIV (top chart) against the VIX (bottom chart). (click thru to view).
Although VIX is moving higher, it remains well below its recent peaks. As our analysis shows, this is typical. ODDS SPXIV, however, is rocketing upward. As of last night, it hit its highest level since October 2002.
In other words, option volatility is not really low! Yes, index option volatility may appear low. But implied volatility of individual equity options is extremely high.
Well, anecdotally I found the bigger volatility picture kind of eh. But Don’s numbers suggest otherwise. But perhaps we are saying the same thing. I don’t find option volatility out of line with stock volatility, even in many financials. But that stock volatility itself is so high, it explains Don’t numbers.
So what’s the explanation for all this?
I’ll take a stab.
You have two very large sectors, financials and energy, often moving violently, but in opposite direction. The net effect maybe causes elevated individual stock volatility, but not enormous stock index volatility.
Remember that “market” volatility has two main drivers. One is the volatility of the stocks themselves, and the other is the degree to which they correlate. Low correlation will depress volatility, so perhaps that is what we have seen.
July 9th, 2008 at 8:30 am
excellent. thank you.
July 9th, 2008 at 9:51 am
Great work Adam, your explanation makes a lot of sense to me.
July 9th, 2008 at 10:45 am
Hey Adam,
Thanks for the article, I guess I’ve been a bit naive only looking at the VIX compared to the individual volatility in equities. Bear with me on this, since the index volatility is relatively low compared to the high volatility in invidual equities, do you think a good income strategy right now would be selling call spreads? We can collect a higher premium due to higher IV & the recent bounce in the market and then cover the positions / let them expire after the next leg downward in the market? –And if this is true, what screening criteria would you look for to determine which equities would be good candidates for this strategy?
Let me know your thoughts, keep the good insight comin’. You guys should get option addict (http://optionaddict.net)to collaborate on this site too, just a random thought. I’m always appreciative of the insight you guys have, thanks again. peace.
- J. Coryea
July 9th, 2008 at 10:58 am
tanks all.
J.: Yes, I like the concept of call vertical spreads (or put vertical spreads) as directional plays. Easy to assess risk/reward, no worries about having to stop out.
Keep in mind though the IV pop won’t change the price you get all that much. Both the option you buy and the option you sell will lift, so it depends on the specifics. Pumped volatility will get you a better price on a spread that is further from the money, but a worse price if it is at the money.
Not sure there’s a great screening process to find this though. I mean you could go to ivolatility.com and do some searches for pumped volatility and if you are looking to short call verticals, you could maybe search for high skews (you’d want setups where the higher strike is abnormally cheap vs. the lower one). You may need a subscription to access all that though.