If you are an options and/or volatility trader, you are wonder where risk will be priced from here. This question is different than where will the S&P 500 move in the battle between bears and bulls, it is merely asking whether credit spreads and implied volatility will continue to be priced with wider than normal risk premiums.
If you simply look at the VIX, it has collapsed from its elevated spiking level and is now hovering around 30%. If you think of this as a daily return forecast, 30% suggests that the S&P 500 will move greater than +/- 1.89% over 1/3 of the trading days. That is a volatile expectation for future daily returns:
Can the VIX break substantially below 30%?
The true question is whether you define this volatility as a risk flare or as the start of something more ominous. If thought to be a continuation of a large bear market or of ex-Lehman Bros. liquidity flight then forget about selling volatility.
My own opinion is that this spike in volatility is a risk flare, which would tend to be shorter in duration.
It is guaranteed that I will lose some readers in the following table, but I thought it was a great way of putting VIX flare ups into context. I went back and pulled VIX closing prices since January 1, 1990. I then looked at how many times the VIX has traded above certain levels and for how long. The following table shows that the period from August 4, 2011 through October 13, 2011 was 50 consecutive trading days where the VIX traded above 30. It shares this space with 4 other such risk flares and there was only one that was longer – 170 trading days during the financial crisis:
The occurrences circles in red correspond to the global financial crisis
I do not believe that this is the Global Financial Crisis Part II, so I doubt that we will see a level on the VIX above 30 for much longer. Markets get tired and all possible worst case scenarios get disseminated over the course of a few months of frantic trading.
