Is The VIX Mispriced?

The VIX spot is trading $16.88, up 9.3% with IV30™ up 7.9% (that's the vol of the vol). The LIVEVOL® Pro Summary is below.

The CBOE Volatility Index - more commonly referred to as "VIX" - is an up-to-the-minute market estimate of expected volatility that is calculated by using real-time S&P 500® Index (SPX) option bid/ask quotes. VIX uses nearby and second nearby options with at least 8 days left to expiration, and then weights them to yield a constant, 30-day measure of the expected volatility of the S&P 500 Index.

I'm examining the vol of the VIX today - pointing out one stark empirical phenomenon, which is the implied vol of the VIX, which seems too low. Yeah, I said it - I also said "appears" so no law suits allowed - this isn't advice.

Like a 3-act movie, I will start with an introduction into the characters and our protagonist to end with the "turning point" - build a little, get caught in no man's land by the middle of the second act ("the point of no return"), and close big with the final act, "all hope is lost" and then a nice and neat resolution.

I will end up explaining this chart as a teaser:

But we're not there yet... So, let's start with a two-year chart of the VIX spot, below.

This is our protagonist. We can see his object of desire is to appropriately reflect the risk over the next 30-days in the S&P 500 Index. His (her?) path is a bumpy one -- there's a gap between expectation and reality, and with each gap, she/he has to do more to reach the object of desire. This builds character, and is in fact a story. Like any good screenplay, it has been a bumpy ride for the protagonist, reaching as high as ~48% and as low as 11.05%.

But the story gets more interesting as we look on a little more myopically. Let the second act begin. Below we are looking at a three-month chart of the VIX spot.

The choppiness is building. In fact, it's within this three-month window that the VIX hit its multi-year low of 11.05%. It has also been as high as 18.51%, which means its upper range in the last quarter has been 67.5% higher than its low. This measures the 30-day forward looking risk of the S&P500 - this ain't a micro-cap bio-tech index.

An interesting headline I saw on Yahoo! Finance read something like "100-Point Dow Swings Are Back." A quote from it is: "For the seventh time in the past ten sessions, the Dow Jones Industrial Average (^DJI) is moving at least 100 points, up or down, from the previous close." The point was clear, the market may be moving away from slow and steady (and up all the time), to, not slow, not steady and not up all the time.

Finally, the last act: this image is breathtaking, and not just because it has lots of pretty colors.

I have included the following historical realized vol measures:

HV60™: The historical realized volatility of the VIX spot over the last 60 trading days.
HV90™: The historical realized volatility of the VIX spot over the last 90 trading days.
HV120™: The historical realized volatility of the VIX spot over the last 120 trading days.
HV180™: The historical realized volatility of the VIX spot over the last 180 trading days.

Note, all of these measures are the darker colors, and they are all on top of the four measures at the bottom.

I have included the following implied vol measures:

IV60™: The implied forward looking volatility of the VIX spot for the next 60 calendar days.
IV90™: The implied forward looking volatility of the VIX spot for the next 90 calendar days.
IV120™: The implied forward looking volatility of the VIX spot for the next 120 calendar days.
IV180™: The implied forward looking volatility of the VIX spot for the next 180 calendar days.

All of these measures are the brighter colors and all are below the four measures at the top.

For every measure of realized vol vs. it's counter part in implied vol. The VIX IV is measuring (reflecting) less forward risk than has been realized in the past. Less risk is reflected in the VIX than previously.

So, if you believe that the market is now in a period of frequent, larger moves, then you wouldn't believe that the forward risk of the VIX spot would be less than the past realized movement - but that is exactly what the VIX options reflect.

My take? If there is a 50/50 chance that VIX vol rises, then the options are mispriced (they would be exactly equal to HV if that was the case -- sort of...). Right now it looks like the option market reflects a higher chance that the VIX spot moves less than it has in the past.. and that, does not seem sound... or does it?.

Disclosure: This is trade analysis, not a recommendation.

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