All is fine, but some “problems” have still not vanished. We have the UK mess still very much alive, and no, investors are not prepared what could come out of the Brexit situation, China is pumping liquidity into the system, not because all is great, the Fed is still reducing the biggest “prop bet” ever. There are of course many other themes to dig deeper into, but our take here is that given the recent bounce and the implosion of global volatilities, there are interesting long convexity trades setting up.

Bigger spikes and elevated volatility seem to be a “new” phenomenon. VIX has gone from 35 to 18 in a few weeks. Sure, markets are currently not moving that much, but could some of the above topics reignite as focus among investors?

Below charts shows the SPX term structure now (orange) versus green (1 month ago when SPX was 250 points lower). Volatility has imploded and the shorter-term maturities have collapsed. If you look at volatility as realized vol only here, you are not looking at the beyond obvious themes.

The VIX futures curve on a five-year chart. Note that the current spike in the VIX futures curve has come back to slightly negative territory again, but we are far from calm markets priced by the VIX futures curve.

Typical for the erratic market that started last autumn is the fact the crowd has been caught wrong in pretty much all consensus trades. The below chart shows the CBOE put call ratio. Investors “loved” puts relatively speaking when SPX traded at 2350. Investors now “hate” puts relatively speaking when SPX trades at 2650. 

Volatility is a mean reverting asset, but can also stay elevated and trade in a trend(y) fashion at times as well. Since the Fed started shrinking the balance sheet (white) the VIX has shown a few huge spikes in a relatively short time period as well as there seems to be somewhat of a trend higher having developed.

Volatility is mean reverting yes, but volatility can stay elevated at times. Few have traded markets for decades, and even fewer do actually understand volatility, and even fewer than that have experienced how it is to trade volatility as an asset when regimes change.

Below chart shows VIX and the fact it actually moves in cycles. Do note that the cycles have been rather equal in terms of years. What if the VIX is establishing a higher plateau and elevated volatility becomes the “new normal”? Is volatility pricing further possible negative macro picture at these VIX levels? Is V2X at 15 pricing a possible Brexit black swan? Etc…

The questions are many, but the most relevant question is whether you are hedged? After all, most people in current markets know only of the bull.

Source: charts by Bloomberg