Volatility Returns to Markets after Long Hiatus

The shoe that is volatility has dropped on a different foot in 2018. Investors had rarely seen a market like that of 2017, where returns were so abundant, and volatility was at its lowest levels in over half a century. An obscure financial tool that was reserved primarily for professional traders, has become a household name at the likes of retail brokers.

Here is why the layman should not play with fire that is the VIX.  The CBOE Volatility Index, known by its ticker symbol VIX, is a popular measure of the stock market’s expectation of volatility implied by S&P 500 index options, calculated and published by the Chicago Board Options Exchange (CBOE). It is colloquially referred to as the fear index or the fear gauge. By definition not for the faint of heart.

VIX is a measure of expected volatility calculated as 100 times the square root of the expected 30-day variance of the S&P 500 rate of return. The variance is annualized and VIX expresses volatility in percentage points.

While the CBOE calculation of the VIX is inherently a statistical measure, it captures the emotions of the marketplace through S&P 500 returns. In 2017, whether it be the Russians or a presidential scandal, the markets, as reflected by the VIX didn’t flinch. We turn the calendar ahead to the first quarter of 2018, and saber rattling with North Korea drops the S&P 500 over 500 points, and finds the VIX surging 80%.

With a predictably bearish posture in the VIX of past years, it has been profitable for many to gain by selling options on the VIX or exchange-traded products. Now, the market volatility has caused a resurgence in options trading, as equity options trading has increased enormously in 2018, according to the Options Clearing, Corp. A number of hedge funds and money managers who realize that volatility is back, are using dips in the VIX to hedge their long portfolios. The causal effect of emotional fear is volatility, and that is positively correlated with the movement of the VIX. Higher fear – higher VIX.

Paraphrasing the efficient market hypothesis, all publically available information, albeit data or event risk, is factored immediately into a securities price, thus the adage, by the rumor, sell the news. The advent of social media and high-speed data have perhaps changed the efficient market hypothesis.  In 2017, event risk news was not moving the VIX, and the market shrugged off any other interpretations and moved higher. However, in the first quarter of 2018, a different interpretation of news has had a different effect on the way it is factored into a securities price. The needle is being moved now by such event risk.

One wonders whether this new found love of the VIX as a market hedge will last, or will money managers revert back to the tried and true method of shorting it. I also wonder where this leaves economists on efficient market theory.

About John Thomas

John Patrick Thomas is a four-time cancer survivor who lives with his family in South Florida. John attended Gettysburg College and The American University before embarking on an entrepreneurial career on Wall Street. He turned to the teaching profession after his life-threatening bout with bone cancer. John has recently written a #1 Amazon Cancer Bestselling book entitled, “A Call to Faith, the Journey of a Cancer Survivor.” He has appeared in publications such as The New York Times, The Wall St. Journal, The Washington Post, Memorial Sloan-Kettering Cancer Center publications, and was featured in new DayStar network series, “Impact with Pastor Dave.” He has traveled as a missionary and may be one of the few people that tell you cancer was the best thing to ever happen to him. You’ll have to ask him why.

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