End of Summer Volatility – Implied to Realized at Nosebleed Levels

By: Mike Zigmont in Volatility Commentary August 25, 2020

In the last days of summer, the VIX is climbing higher – an understandable development given that September, a notoriously volatile month, is around the corner and the markets have been on a huge tear. But the contrast of implied volatility (which the VIX measures) with the sleepy August trading we’ve been experiencing could not be greater. The VIX premium to 20-day realized volatility is now at 15 points – putting it in the top 0.2% of all readings going back to 2003.

There is no shortage of reasons to be think realized volatility won’t increase as we turn the corner after Labor Day. October will bring the Q3 earnings season, November will bring the election – which may or may not yield an obvious winter on the morning after. But aren’t these already priced in? The tech overextension, for example, appears to be well considered by the volatility markets: the VXN (a VIX for the NDX) spread to the VIX is now nearly 9 points – a multi-year high and is in top 2% of all readings going back to 2013.

Similarly, and as we have discussed at length in recent weeks, the election premium is also well considered by the VIX market. For example, the premium of the October contract over the average of the September and November contracts continues to trade higher (even as Biden’s apparent lead shrinks).

U.S. Is a Global Leader in Equity Volatility. The pandemic is global and has engulfed virtually every economy and stock market in the world – more or less at the same time. But while all stock markets have been contending with the massive uncertainties that a pandemic like this might bring, what is striking is how high the U.S., and U.S. tech in particular, implied volatility levels is relative to foreign markets.

So what to take away from this? Well clearly the U.S. has a contentious election to contend with. But the equity market knows that too as it squeaks out fresh highs. Beyond that, perhaps this is essentially a statement that the bigger volatility can be expected from the market or sector where the stocks have run the most, as opposed to whether some Earth-shattering macro catalyst is likely to devastate the market.

Ultimately, we think these global volatility metrics help paint the picture that the VIX’s downward journey from March is not yet over. Tech is clearly overextended and due for a correction, but also keep in mind that tech can consolidate through a rotation, not an overall market sell-off….and a rotation might mean a stable market (and lower VIX).

That’s a lot of “mights” so amidst volatility, we have uncertainty, which makes working with a steady and experienced hand a solid strategy as all of this continues to unfold.

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