The Absence of Fear

by Tyler Craig on July 13, 2012

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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.

For related posts, readers can check out:
The Fear Fest Resolution
VIX Trading Resource Guide
The VIX and Numbing News

{ 4 comments… read them below or add one }

Gav July 14, 2012 at 7:51 am

Great article Tyler, I don’t think many people understand VXX, VXZ and TVIX. Too many people are blindly holing these ETN’s and thinking they are protected from volatility spikes. I explain a bit about the contango effect in this post which your readers might be interested in.


Tyler Craig July 15, 2012 at 7:06 pm

Thanks for the addition Gav. No doubt many sidestep the proper due diligence with these pups to their own peril.


Peter J Pinto July 17, 2012 at 2:49 pm

Hi Tyler

Thanks for your generosity in sharing your knowledge and skills.
Is it possible that because of known manipulation of the market keeping interest rates low and adding liquidity, removes some of the unknown that fear feeds upon? With fear inherent in the VIX, could this account for its aberrant behavior?


Tyler Craig July 19, 2012 at 7:35 am

Hi Peter

Good question. The phenomenon I’m pointing to in the post is a very short-term event. A lack of fear during the six day selloff. The heavy-handed Fed has been with us for years so for that to be the root cause of a weird VIX or excessive complacency then we would have had to of seen the VIX eerily quiet for a long time. Given the sharp VIX spikes of 2010 and 2011, I’d say on balance that has not been the case.


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