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Where Is the Volatility?

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Examining the Current Low Volatility Environment

With all of the volatile polit­i­cal events hap­pen­ing domes­ti­cal­ly and inter­na­tion­al­ly, the low mar­ket volatil­i­ty over the past few years has puz­zled investors. Many look at the low VIX and are con­fused as to why the mar­kets don’t seem to be respond­ing to unsteady cur­rent events in a cor­re­spond­ing fash­ion.

There are many rea­sons why volatil­i­ty is low. There are inter­twined rela­tion­ships in the finan­cial mar­kets today, and assess­ing these rela­tion­ships can pro­vide a bet­ter under­stand­ing of volatil­i­ty with­in a present and his­tor­i­cal con­text.

Misconceptions about the Volatility and the VIX

Many investors look at volatil­i­ty and, more specif­i­cal­ly, the VIX as indi­ca­tors of fear in the mar­ket. Con­trary to pop­u­lar belief, volatil­i­ty is not an indi­ca­tion of fear. Volatil­i­ty is sim­ply the mea­sure­ment of sup­ply and demand man­i­fest­ed through mar­ket par­tic­i­pants active­ly buy­ing and sell­ing.

Unfor­tu­nate­ly, the VIX has a rep­u­ta­tion that it should accu­rate­ly mea­sure the risk in the mar­ket­place and serve as a “one-stop-shop” indi­ca­tor for it. The expec­ta­tion that the VIX is an actu­al rep­re­sen­ta­tion of volatil­i­ty or risk is inac­cu­rate. Not sur­pris­ing­ly, the reli­a­bil­i­ty of the VIX as a pre­dic­tor of future mar­ket move­ments has suf­fered in recent years, and many incor­rect­ly inter­pret this as if it sim­ply does not work any­more. The VIX is not bro­ken because it con­tin­ues to mea­sure what it was always designed to mea­sure: the implied volatil­i­ty of 30-day options in the S&P 500 index.

The VIX mere­ly mea­sures how many investors are buy­ing or sell­ing short-term options and can be used as a barom­e­ter for how much port­fo­lio “insur­ance” is being pur­chased via SPX options. Insur­ance can be pur­chased for pro­tect­ing down­side mar­ket move­ments or upside move­ments, the lat­ter in an attempt to par­tic­i­pate with mar­ket gains. Recent­ly, there has been an increase in buy­ers of upside VIX calls and VIX call spreads. What this means is that port­fo­lio man­agers are using VIX calls to hedge increas­es in volatil­i­ty, and this has had a damp­en­ing effect on SPX option volatil­i­ty.

How Low Is Volatility Really?

Going into the sum­mer of 2017, S&P 500 real­ized volatil­i­ty was in the low sin­gle-dig­it per­centiles of its dis­tri­b­u­tion range going back near­ly 90 years. Mea­sures of S&P 500 short term implied volatil­i­ty expressed by the VIX Index in late July 2017 touched an all-time intra­day record low of 8.84.

This low volatil­i­ty envi­ron­ment, how­ev­er, is noth­ing new. The VIX expe­ri­enced low bouts of volatil­i­ty like this in 2005 and 2006. Volatil­i­ty cycles between high and low peri­ods, just as all mar­ket cycles under­go some degree of change either through exter­nal stim­uli or evo­lu­tion.

The dai­ly clos­ing his­tor­i­cal aver­age (since 1990) of the VIX has been slow­ly declin­ing and now stands at 19.4. Since 2003, the VIX has closed below 16.25 approx­i­mate­ly 50% of the time, and half of those occur­rences have been under 13.2. With this in mind, a VIX in the 12–13 range is not “sur­pris­ing­ly” low.

VIX Occurrences since 2003 | Swan Blog - Where Is the Volatility? | Swan Global Investments

Source: TradeSta­tion, Swan Glob­al Invest­ments


The cur­rent streak of no VIX clos­es above 20 is the third longest in his­to­ry. The longest one occurred between 2004–2006 and last­ed 558 days. Anoth­er notable peri­od was between 1991 and 1996 when cen­tral banks were also accom­moda­tive in a pro-busi­ness envi­ron­ment.

Going back to 1928, com­pa­ra­ble low volatil­i­ty (his­tor­i­cal) peri­ods have had a medi­an length of 15–16 months (Gold­man Sachs, 2017), and there were sev­er­al peri­ods that last­ed more than three years, so it is plau­si­ble that the cur­rent volatil­i­ty regime extends fur­ther in time.


S&P 500 Historic Six Month Realized Vol 1928 - mid-2017 | Swan Blog - Where Is the Volatility? | Swan Global Investments

Source: BAML


In addi­tion, not only is US equi­ty volatil­i­ty extreme­ly low, glob­al volatil­i­ty, includ­ing com­modi­ties and cur­ren­cies, has fol­lowed suit.


Global Asset Class Volatility Percentiles as of May 2017 | Swan Blog - Where Is the Volatility? | Swan Global Investments

Source: BAML 2017


A break from this “new nor­mal” may be dri­ven by increas­ing lever­age and inter­est rates or a reduc­tion of cen­tral bank bal­ance sheets, or a big geopo­lit­i­cal shock. With the 2017 year behind us, the month­ly aver­age of the VIX is on pace to be the low­est in 15 years.

Why Is Volatility So Low?

There are many the­o­ries as to why volatil­i­ty has declined to these lev­els despite the cur­rent polit­i­cal and cul­tur­al cli­mate. In com­plex, open-end­ed sys­tems like finan­cial mar­kets, it is hard to pin out­comes to a sin­gle vari­able.

Long-Term Volatility & Structural Shifts

When ana­lyz­ing volatil­i­ty, it is unfit­ting to equate short-term volatil­i­ty move­ment with long-term volatil­i­ty move­ments. While the VIX can be very reac­tive in the short-term, long-term volatil­i­ty is less sen­si­tive to short-term events and more sus­cep­tive to struc­tur­al shifts. These struc­tur­al shifts can occur because of dif­fer­ent phas­es in the busi­ness cycle—such as weak­ness in the econ­o­my or a slow­down in cor­po­rate earnings—or, as in the case today, asset cor­re­la­tions drop­ping. Index volatil­i­ty is a func­tion of sin­gle stock volatil­i­ty, and if sin­gle stock cor­re­la­tions remain mut­ed, this trans­lates into low­er index volatil­i­ty.

Trend to Passive Investing

Over the past year, Bloomberg data shows over $700 bil­lion has flowed into broad-based pas­sive funds/ETFs while active mutu­al funds have suf­fered redemp­tions of $240 bil­lion. In the­o­ry, if this increase in pas­sive inflows was the prin­ci­pal cat­a­lyst for ris­ing equi­ty prices, S&P 500 cor­re­la­tion lev­els should rise in lock­step, but the oppo­site has hap­pened, with index cor­re­la­tions near record lows. This means that pas­sive flows into broad-based indices are not uni­form­ly rais­ing all stocks.

Reduction in Hedging Activity

With volatil­i­ty so low, the cost of hedg­ing a port­fo­lio has been reduced to at or near ten -year lows. Even so, many port­fo­lio man­agers are elect­ing to forego hedg­ing in a fee­ble attempt to add “alpha,” ignor­ing the pos­si­bil­i­ty of sys­tem­at­ic mar­ket declines. The deci­sion to not hedge has had an impact on volatil­i­ty sim­ply because there are few­er buy­ers of option pre­mi­um.

Oth­er ele­ments con­tribut­ing to sub­dued volatil­i­ty are the impact of risk par­i­ty funds, the pro­lif­er­a­tion of sys­tem­at­ic volatil­i­ty pre­mi­um har­vest­ing pro­grams, and macro decor­re­la­tion.

Prepare for the Unpredictable

It is dif­fi­cult to deter­mine what exact­ly is caus­ing this extend­ed low-volatil­i­ty envi­ron­ment or to pre­dict how long it will last. Even if high cor­re­la­tions are dis­cov­ered, they rarely remain con­stant. With­out being able to pin­point a spe­cif­ic cause, it is vir­tu­al­ly impos­si­ble to pre­dict what will result in a spike or when the low volatil­i­ty will end. This, cou­pled with the frail­ties of human nature, presents a low prob­a­bil­i­ty expec­ta­tion for mar­ket tim­ing strate­gies.

So, what is the best way to han­dle the unpre­dictable and uncer­tain low volatil­i­ty envi­ron­ment?  To remain always invest­ed and always hedged.


About the Author

Chris Hausman, CMT®, Director of Risk Management and Chief Technical Strategist

Chris Haus­man, CMT®, Direc­tor of Risk Man­age­ment and Chief Tech­ni­cal Strate­gist, focus­es on risk assess­ment and man­age­ment for the Defined Risk Strat­e­gy invest­ments and posi­tions. He mon­i­tors risk across all of Swan’s port­fo­lios and pre­pares stress tests, risk assess­ment reports and con­tributes to strate­gic deci­sion mak­ing for the invest­ment man­age­ment team, as well as serv­ing as an addi­tion­al lay­er of over­sight for the trad­ing team. As a Char­tered Mar­ket Tech­ni­cian, he also acts as Chief Tech­ni­cal Strate­gist at Swan Glob­al Invest­ments.



Impor­tant Notes and Dis­clo­sures:

Swan Glob­al Invest­ments, LLC is a SEC reg­is­tered Invest­ment Advi­sor that spe­cial­izes in man­ag­ing mon­ey using the pro­pri­etary Defined Risk Strat­e­gy (“DRS”). SEC reg­is­tra­tion does not denote any spe­cial train­ing or qual­i­fi­ca­tion con­ferred by the SEC. Swan offers and man­ages the DRS for investors includ­ing indi­vid­u­als, insti­tu­tions and oth­er invest­ment advi­sor firms. Any his­tor­i­cal num­bers, awards and recog­ni­tions pre­sent­ed are based on the per­for­mance of a (GIPS®) com­pos­ite, Swan’s DRS Select Com­pos­ite, which includes non-qual­i­fied dis­cre­tionary accounts invest­ed in since incep­tion, July 1997, and are net of fees and expens­es. Swan claims com­pli­ance with the Glob­al Invest­ment Per­for­mance Stan­dards (GIPS®).

All Swan prod­ucts uti­lize the Defined Risk Strat­e­gy (“DRS”), but may vary by asset class, reg­u­la­to­ry offer­ing type, etc. Accord­ing­ly, all Swan DRS prod­uct offer­ings will have dif­fer­ent per­for­mance results due to offer­ing dif­fer­ences and com­par­ing results among the Swan prod­ucts and com­pos­ites may be of lim­it­ed use. All data used here­in; includ­ing the sta­tis­ti­cal infor­ma­tion, ver­i­fi­ca­tion and per­for­mance reports are avail­able upon request. The S&P 500 Index is a mar­ket cap weight­ed index of 500 wide­ly held stocks often used as a proxy for the over­all U.S. equi­ty mar­ket. Index­es are unman­aged and have no fees or expens­es. An invest­ment can­not be made direct­ly in an index. Swan’s invest­ments may con­sist of secu­ri­ties which vary sig­nif­i­cant­ly from those in the bench­mark index­es list­ed above and per­for­mance cal­cu­la­tion meth­ods may not be entire­ly com­pa­ra­ble. Accord­ing­ly, com­par­ing results shown to those of such index­es may be of lim­it­ed use. The adviser’s depen­dence on its DRS process and judg­ments about the attrac­tive­ness, val­ue and poten­tial appre­ci­a­tion of par­tic­u­lar ETFs and options in which the advis­er invests or writes may prove to be incor­rect and may not pro­duce the desired results. There is no guar­an­tee any invest­ment or the DRS will meet its objec­tives. All invest­ments involve the risk of poten­tial invest­ment loss­es as well as the poten­tial for invest­ment gains. Pri­or per­for­mance is not a guar­an­tee of future results and there can be no assur­ance, and investors should not assume, that future per­for­mance will be com­pa­ra­ble to past per­for­mance. All invest­ment strate­gies have the poten­tial for prof­it or loss. Fur­ther infor­ma­tion is avail­able upon request by con­tact­ing the com­pa­ny direct­ly at 970–382-8901 or www.swanglobalinvestments.com005-SGI-010418




By |2018-10-02T11:02:06+00:00January 4th, 2018|Blog|Comments Off on Where Is the Volatility?