On Monday we outlined that volatility in the US was simply too low and that US equity volatility had not been pricing in the global Emerging Markets risk off sentiment. We suggested:
“VIX on the other hand continues trading extremely complacent. We agree the SPX index doesn’t move much on a daily basis, but should the Emerging Market crisis go global, VIX will at some stage need to start pricing this risk as well”.
During the course of the week, US equity volatility has spiked rather substantially.
NASDAQ volatility, VXN, is up 35% from lows we saw a few days ago.
The broader fear index, the VIX, is up approximately 30% during the same time.
Our favourite options philosopher, Nassim Taleb, has written many books worth reading for the active traders. One of the best conclusions is:
“Don’t buy volatility (protection) when you must, buy volatility when you can”
Running to buy protection in form of volatility is probably a late trade for the short term. Volatility is a mean reverting asset over time and chasing it is often not a great strategy.
Below chart shows the CBOE put/call index. We have seen a huge jump in people buying puts compared to calls, ie investors buying protection. This is often proved to be a short term contrarian signal, ie people buy protection too late.
For now SPX still remains trading within the positive trend. The short term opportunity of using VIX as the optimal EM risk hedge played out well but is at these levels not offering the same attractive risk/reward scenario.
Source: charts by Bloomberg