Holiday VIX Wear
It’s one of those times of year again where I like to pre-warn about something. Ignore all volatility indices and measures. Or at least take them with a grain of salt.
All volatility measurements basically take all the *fixed* info, I.e. the stock price, the strike, interest rates, dividends, time until expiration, and price of the actual option and then *solve* for the unknown variable; volatility.
But what that formula does not account for is that all *time* is not created equal. What I mean is as of Friday, we face two weeks of late summer that see notoriously high traffic in the Hamptons and notoriously low traffic in the pits. It is traditionally a very slow stretch until after Labor Day, which is conveniently almost exactly halfway through the September expiration cycle.
In other words, tomorrow, September options will have 35 calender days until expiration. But in reality, the first 18 of them figure to be very non-volatile.
Option traders anticipate this, and condense time to some extent. What that means is they effectively pretend options with 35 days until expiration really only have 25 days until expiration, something like that (I’m making up the number to make the point). But remember the volatility calculations you see everywhere don’t know this. They basically assume the calender is correct. And thus volatility looks cheaper. But it’s strictly a calculation quirk. “Real” volatility and pricing of fear has not budged, it’s only a realistic discounting of “time” that has gone on.
Perhaps the simplest way to account for this is to avoid watching the actual VIX for the next couple weeks, and pay more attention to VIX futures and options. These are trading markets, and as such will price in the holiday. Right now they expect about a 23 VIX in September. It’s likely over the next couple weeks that the *cash* VIX will drop, while this will stay constant. If that in fact happens, i.e. you see an unusually large premium from the futures to the cash, it’s not all that meaningful. If it deviates however, that’s something to note.