Market Risk From Election Day to Q1 2021

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Market Risk From Election Day to Q1 2021

Every month we dedicate one Data section to implied volatilities; given recent volatility we will focus on the CBOE VIX Index today in our usual 3-point format:

#1: First up, let’s look at the prices of all upcoming expirations for a sense of how this market is considering future S&P 500 volatility over the next few months and into 2021:

Here are those levels as of today’s close, the peak observation bolded:

  • Spot VIX: 27.78
  • 10/21 expiration: 31.30
  • 11/18: 31.65
  • 12/16: 30.90
  • 1/20/21: 30.30
  • 2/17/21: 29.51
  • 3/17/21: 29.15

Takeaway #1: those future VIX levels are noticeably elevated versus historical norms. The long run average of the VIX back to 1990 is 19.4 and the standard deviation of that time series is 8.1. That puts all those out-month contract prices at greater than 1 sigma from the mean (27.5). We can chalk up the 11/18 high point of 31.65 to the US Presidential election, but the 29-30 levels of Q1 2021 indicate that the options market believes COVID-related uncertainties will linger into the new year. More on this in a minute…

Takeaway #2: on a sort-of comforting note, today’s spot VIX close of 27.8 is basically indistinguishable from the 1 standard deviation level of 27.5. We would also note that the VIX is actually lower than its September 3rd close of 33.6 even though the S&P 500 is down 5.0% from that day (the correlation between these 2 usually works the other way). Both observations indicate that the VIX is not that “concerned” about another volatility shoe dropping soon.

#2: Leveraging our 2009 Playbook concept of comparing the initial liftoff after the Financial Crisis to this year’s COVID Crisis, let’s look at where the VIX traded in September 2009 and through Q4 of that year:

  • The average VIX level for September was 24.9
  • The high was 29.2 on September 1st, 2009 and the low was 23.1 on September 22nd
  • For Q4 2009, the average was 23.1 with a range of 19.5 – 30.7

Takeaway #1: the VIX remains elevated long after the depths of a crisis, as we can see with September 2009’s mean reading of 24.9 or Q4 2009’s 23.1 (even including the usual December drop in the VIX). Don’t, in other words, expect to see 2020’s VIX drop below the long run mean of 19.4 any time soon.

Takeaway #2: the 12% difference between today’s VIX close of 27.8 and September 2009’s average of 24.9 is a reasonable way of thinking about how much 2020’s political uncertainty is affecting US equity volatility. It is measurable, but not as large as one might think.

#3: Lastly, we need to remember that the long run history of the VIX is really a tale of 2 sorts of markets – wild or mild – and these tend to cluster. The chart below has a marker for March 1994 just to highlight the “20” y-axis line that is essentially the long run average. Note that there are many years (1997 – 2003, 2007 – 2012) when the VIX consistently runs hot, in keeping with higher levels of actual S&P volatility. Then there are other years when it seems to go to sleep (1992 – 1996, 2003 – 2007, 2012 – 2019), also mirroring limited price churn in the index.

Takeaway, and final thought: US stocks can still work when the VIX is over 20 for years on end (late 1990s, 2009 – 2012) and history says that combination can last for quite a while. As we look at that chart, we can easily envision the VIX staying above 20 through 2025, just as it did through the late stages of the dot com bubble or after the Financial Crisis. In the end, that’s most likely why the forward VIX contracts we started this section with are trading the way they are. Options markets know their history.