Medium-Term Volatility Expectations Down; Earnings Season Starts Today
S&P 500: Past Highs May Provide Support, But…
S&P 500 (SPX) declined for 4 days in a row in the week before Easter and yesterday. It got close to the upper border of the resistance zone from February this year, which now becomes a support (highest intraday high was 1378.04 on 29 February). There are several meaningful levels between 1340 and 1380 which market participants may remember from 2011 or early 2012. These levels may provide some support, should the market fall further. Nevertheless, the technicals won’t be enough to save the market if we see ugly fundamentals in the weeks ahead (the earnings season that starts today, employment data and other macro, hints from the Fed, or further drama in Europe).
S&P 500 Realized Volatility
Realized volatility continues to increase from the extra lows in the first two months of 2012, but only very slowly. 21-day historical volatility of SPX is now at 11.25% (annualized).
VIX Index Leaves the 14-17 Range
VIX Index (CBOE Volatility Index – measures implied volatility of 30-day SPX options) left its narrow range of the 2-3 weeks before and yesterday it got above 18 for the first time since 8 March – almost exactly one month ago. The main themes remain the same:
- The current level of VIX seems rather low in the context of the last several years and also in the context of all the fundamental economic difficulties we are facing.
- However, SPX implied volatility remains at huge premium to realized volatility (18.81 spot VIX vs 11.25 21-day historical volatility at yesterday’s close).
Term Structure of Volatility: Expectations Change
What I find more interesting than spot VIX at this moment is the recent change in the term structure of volatility. We can see it both in the relationship of VIX and VXV (93-day version of VIX) and on the VIX futures curve.
VIX/VXV Ratio Up from Extreme Lows
VIX/VXV Ratio (see chart below) ended at 0.89 yesterday, the highest since 7 March. In general, VIX/VXV ratio tends to be higher when spot VIX is higher, and lower when spot VIX is lower. Around the middle of March we saw this ratio at extremely low levels – the lowest VIX/VXV was before the close on 16 March 2012 (0.68). In the last 2 weeks VIX/VXV Ratio came back to the area between 0.8 and 0.9 – levels quite common in history for VIX below 20.
In the end of February and at start of March, the last time VIX was about the same as yesterday (18-19), VXV was 21-22, some 3 VIX points higher than yesterday. VXV (medium term implied volatility) has underperformed VIX (short term implied volatility) in the last several weeks.
Blue = VXV; Black = VIX; Green = VIX/VXV Ratio
VIX Futures Curve Flattens
VIX futures curve flattened markedly in the last 2-3 weeks (after being extremely steep in February and early March). The distribution of the contango among individual sections of the curve also changed. One or two months ago, the curve was concave and most of the steepness could be found on the short end of the curve (there was big difference between the first and the second futures month, and between these front months and spot VIX, but much smaller differences in the more distant months). Today, VIX futures curve looks almost like a straight (but still upward sloping) line.
Compared to what it looked like before and on the relative basis (to other maturities), the middle of VIX futures curve (June, July, or August) looks quite cheap now. Of course there are big risks in VIX futures spread positions, as the short end of the curve usually moves much more than the middle and the long end.
Fundamentals This Week
Alcoa (AA) starts US earnings season after close today (we are some 100 SPX points higher since the previous earnings season started in January). The macro data release calendar is relatively quieter this week, but there will be some interesting inflation data on Thursday (PPI) and Friday (CPI) and a few others (Trade Balance, Michigan Sentiment, and – as every week – Jobless Claims). Outside the US, there will be ECB Monthly Report on Thursday, and Chinese GDP and German CPI on Friday.