November wrapped up in mostly quiet fashion—typical for this time of year. The S&P 500 (SPX) logged a series of narrow daily trading ranges and, despite a bit of mid-month turbulence, clings to a modest year-to-date advance heading into the final weeks of 2015.
At the same time, many measures of market volatility are well below levels seen at the start of the year. The granddaddy of mood readers—the CBOE Volatility Index (VIX)—was near 20 at the end of 2014, but has recently dipped back to the mid-teens. The index tracks the implied volatility priced into short-term SPX options. It’s a far cry from its 2015 closing high of 40.74 set on August 24 (figure 1).
Actual Volatility? It’s Down, Too
During the news-packed, head-spinning two months ending September 30, the SPX recorded average daily moves of 21 points. Fast-forward to November, and the average daily move was less than 11 points. In other words, actual volatility was down sharply.
While VIX is computed using a theoretical options pricing model and reflects collective expectations for the short-term future, historical or statistical volatility measures the annualized standard deviation of price changes over a previous period of time, say 20, 30, 50, or 90 days.
Figure 2 shows how 20-day SPX historical volatility had plummeted in recent months and is back near 12.
At 15, VIX is nearly three points higher than the market’s actual volatility of 12. Compare that to August 24—one of the wildest trading days in recent memory—when the volatility index was touching 2015 highs. VIX then was more than double the SPX 20-day historical volatility, which had risen to 20. However, after the panic, VIX started moving lower, falling well below 20-day historical volatility, as actual volatility remained somewhat elevated. To illustrate, the difference between VIX and the 20-day HV is plotted in figure 3. Notice that spike in August, followed by the steep fall in September, and then the uptrend since early October.
Read Between the Lines
In sum, VIX at 15 is low relative to levels seen three months ago, but not compared to the market’s actual volatility. The recent readings are consistent with a trend of running above SPX historical volatility, unless a spike in risk perceptions throws the relationship out of whack.
Looking forward, historical volatility typically eases heading into the holidays in late December and early January. If VIX remains at current levels or higher, it could be an indication that investors are pricing in the possibility for increased volatility in early 2016.
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