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Implied Volatility is Set for a Slow Grind Lower

December 5, 2011 By Steven Place


Last week the markets had a sharp move higher. The majority of the move occurred during the overnight session. This relationship has led to a move lower in intraday volatility while "gap risk" remians high.

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If Europe starts to cool off, the gap risk goes away (and that's a big IF), and realized volatility collapses.

But Implied Volatility will stay hot.

This condition happened in 2010. Europe got pushed to the side in the macro scene, but the $VIX stayed elevated.

In fact, it was a slow grind lower before vol finally bottomed out in the 15s.

I think something similar will occur. While the VIX as it stands at 25 may be on the low side right now, we'll most likely see a slow, downtrending environment with 2 major factors:

1. Implied vol will remain high in spite of declining actual volatility as option buyers are still fearful of event volatility that no longer exists.

2. VX futures will go into contango as near term perceived risk will not be that high, but something will happen "just around the corner"

Given these conditions, selling volatility will continue to be a pretty good trade going into about March-- assuming the market doesn't fall apart. Also, $VXX will develop a mathematical "headwind" with the contango, and $XIV will be a decent trading vehicle.

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