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Is the Volatility Market Too Complacent?

Equity markets have seen the steepest correction since this past summer.

But the volatility market seems "flat" -- does this mean we have lower to go?

Here is a daily chart of the VIX:

While equities have cascaded lower, there has not been a higher high registered in the VIX. Is the fear index broken?

Probably not.

The first thing to consider is that you can't view the VIX in a vacuum-- you have to consider other assets and other timeframes.

The VIX is a 30-day reading, which means it shows what the market expects in 30 days.

What's in 30 days? The winter holidays-- this time normally marks low realized volatility as trade facilitation is lower as institutions wrap up their books for the end of year.

Can we look at a longer term volatility reading? Yes-- the VXV is a 90-day volatility measurement:

So longer term volatility has been making higher highs with the equity downdraft-- this shows us that there is a "normal" reaction in the volatility markets, just further out in time.

There is also one other cause to the supply in the options market-- investors are using covered calls to take advantage of special dividends and to hedge against tax-based risk in 2013.

Here's a detailed explanation by geckler from twitter:

The volatility skew has thrown a few less talented traders for a loop as the VIX has broken correlation with other risk indicators. The reason for this the one reliable trade still out there: the covered call write on high dividend names in order to capture special dividends companies are issuing ever since WYNN got the show started last month. The offer of at-the-money and slightly out-of-the-money options has had a drag-on negative effect on the VIX where traders would otherwise expect an aggressive volatility bid.

Overall my trade thesis remains the same-- if you're going to sell options, go further out in time to reduce initial risk and have a better expectancy over time.

by Steven Place

Steven Place is the founder and head trader at investingwithoptions.com/