Monday, October 9, 2017

The VIX also rises

Deep in the recesses of my memory from my youth, I recall reading an Ernest Hemingway quote that went something like this:
How did you go bankrupt?
Two ways. Gradually, then suddenly.

From The VIX Also Rises
The VIX closed at an all-time low last week. Anyone who bought volatility in the last couple of years would have suffered the same fate outlined in the Hemingway novel.

To be sure, there are good reasons for the VIX decline. One reason is the drop in pair-wise correlation between stocks. When this happens, the diversification effect of owning different stocks rises, which depresses index volatility relative to individual stock volatility.

It isn't just the VIX, but the volatility of other asset classes have also fallen. The MOVE Index, which measures interest rate volatility, is also at depressed levels.

Charlie Bilello recently asked if shorting volatility is a free lunch. The answer is an emphatic "no", because traders who take on that trade have to live with the possibility of 90%+ drawdowns. Bilello went on to state that drawdowns from a short VIX position "is not a question of if but when", though he was silent on the timing, or the trigger for such an event.

With overall realized volatility at historically low levels across all asset classes, the trigger for a VIX spike might come from a non-equity asset class.

The full post can be found at our new site here.

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