Condor Options

Volatility Tracker for the week of July 27, 2009

Equities continued to rally last week in defiance of any “overbought” technical readings. [4] Nevertheless, until the contrary signals noted last week abate – specifically, the term structure of volatility futures [7] and the VIX Premium Ratio [8] – I don’t anticipate much upside potential. Note that the Nasdaq 100 Implied Volatility Index (VXN) rose on the week [2] – though this is just as likely due to out of the money call buying by bullish latecomers as it is a bearish omen.

Another reason for caution on a longer-term basis may be the elevated correlation among large-cap S&P 500 components. The CBOE introduced its Implied Correlation Index last week, and I now track a continuous version of that index here. [10] Notice that even as implied volatility indexes have returned to “pre-Lehman” levels, implied correlation has remained unusually high. When correlations are high, there is less refuge to be found in case of a major negative event, and market commentators have noted unprecedented correlations with U.S. stocks even among traditionally unlinked classes like commodities and emerging markets.

In this environment, it makes less sense to discuss oil and gold as distinct assets, since for now we can expect them to move in line with equities. I would prefer to reduce or eliminate any long-side exposure remaining from the trades suggested here earlier this month.

1. Comment.  Highlights items of note in the data below along with our short-term volatility bias and any trading theses. The Expected Daily Move table displays the de-annualized price and percentage change in each underlying asset as implied by its volatility index, within one standard deviation. The Forward Bias table displays my bias for the movement of the price and implied volatility of several assets for the coming week.
2. Weekly Change. Tracks the weekly percentage change in the assets listed and in their implied volatility indexes.
3. Implied Volatility Indexes. A one year chart of the implied volatility indexes for the S&P 500, gold, oil, and USD/EUR. Indexes for the Nasdaq 100 and Russell 2000 are omitted because of their tight correlation with VIX.
4. S&P 500 Price and Bollinger Bands.  Tracks daily closing prices in SPX with an overlay of one and two standard deviation 50-day bands.
5. S&P 500 Implied and Realized Volatility.  Tracks the 21-, 60-, and 90-day realized (or “historical”) volatility of the index and the 21-day lagged CBOE Implied Volatility Index (“VIX”).  Realized volatility is displayed as the annualized standard deviation of lognormal returns over the period specified, and may be thought of as a backward-looking measurement of price behavior.  Implied volatility is the annualized standard deviation of returns implied by option prices, and may be thought of as a forward-looking measurement of expected price behavior.
6. S&P 500 Implied/Realized Volatility Ratio.  Tracks the ratio of 21-day lagged implied volatility (IV) to 21-day realized volatility (RV).  This ratio asks how well IV from one month ago predicted the RV over the next 21 trading days (roughly, 30 calendar days).  When IV correctly anticipates RV over the period, the ratio will hover near 1; we regard the area near 0.9 – 1.2 as normal, given the persistence of a volatility risk premium in equity market derivatives.  A ratio less (greater) than 1 indicates that the price behavior of the underlying asset was more (less) volatile than anticipated.
7. Volatility Futures Term Structure.  Tracks the Friday closing prices of the Volatility Futures complex (VIX, VXD, RVX) for the two weeks prior, along with the spot levels for reference.
8. VIX Premium Ratio.  Tracks the ratio of rolling three-month (VXV) to one-month (VIX) implied volatility.  Periods in which one-month readings persist at an extreme premium or discount to three-month levels have tended to coincide with major market moves.
9. S&P 500 Daily Return Distribution (3 month). Histogram plotting the frequency of daily percentage returns over the prior 63 trading days.
10. Implied Correlation Index. Reflects the market-capitalization weighted average correlation of the 50 largest components of the S&P 500.
11. Gold Price and Bollinger Bands.  Tracks daily closing prices in GLD with an overlay of one and two standard deviation 50-day bands.
12. Gold Implied and Realized Volatility.  Tracks the 21-, 60-, and 90-day realized (or “historical”) volatility of the ETF and the 21-day lagged CBOE Gold Volatility Index (“GVZ”).
13. Gold Implied/Realized Volatility Ratio.  See #6 above; given the novelty of the VIX-style gold volatility index (GVZ) and the characteristics of the underlying, we do not yet have a range we regard as normal.
14. Gold Daily Return Distribution (3 month). See #9 above.
15-18. Oil charts correspond to 11-14 above.