With the market down six days in a row one might think fear would be permeating Wall Street. But, curious enough, fear – at least as measured by the CBOE Volatility Index (VIX) – has been notably absent during the recent selling bonanza. While the S&P 500 Index is down 2.8% since last Thursday’s open, the VIX is only up 4% – a pittance compared to its performance during other comparable market corrections.
Worse yet, the IPath S&P 500 VIX Short-Term Futures ETN (VXX), is up a mere 1% no doubt disappointing any short-term traders who snatched up shares last week in hopes of cashing in on the recent market weakness.
So believe what you will about the current six day losing streak, but it certainly is not causing a mad dash into the options mart in search of protection. Of course the apparent lack of concern can be interpreted a few different ways. From a bullish perspective we might make the case that the volatility markets are acting as a leading indicator. The unwillingness of option players to bid-up implied volatility may be signaling the sell-off is either close to termination or will continue to be fairly benign.
On the other hand, cynics might say option traders are asleep at the switch and in for a rude awakening if the selloff persists. Such a sour turn of events may eventually lead to a rapid lift in the VIX as traders come to terms with a more volatile reality.
Perhaps the strongest argument for the sleepy VIX can be made by putting recent market movements in proper context. Interestingly, actual market volatility as measured by 21 day historical volatility has been falling during the six-day market slide, not rising. While the correction may be characterized as persistent it may not be characterized as all that volatile. Over the past week 21 day HV has fallen from 18% to 16%. Since June 29th it’s actually dropped from 20% to 16%. I suspect this explains in large part the aforementioned unwillingness of option traders to bid option prices any higher.
VXX’s poor performance has been further exacerbated by the term structure of VIX futures remaining firmly entrenched in contango territory. If VXX is unable to get off the floor during a market selloff you can imagine how it will behave when the bulls return to lift the market from current levels.