Curb Your VIX Enthusiasm

I’ve often said here that the market has been anticipating an uptick in volatility and the VIX this fall since the May VIX surge ebbed away. Now that summer is almost over, we can look back to see how selling options actually did between the time the VIX peaked and now.

In the words of the great Larry David on “Curb Your Enthusiasm,” “Pretty good. Pret-ty, pret-ty, pret-ty good.”

The chart below is a comparison of CBOE S&P 500 BuyWrite Index (BXM) in black versus the S&P 500 (SPX) in yellow over the past three months.

BXM owns SPX and writes the nearest at-the-money (ATM) call each month, holds the position for one month, and then rolls into the next cycle.

As you can see, such a strategy worked nicely. Since May 21, the perception of SPX volatility outweighed the reality of a garden variety summer churn.

You want to avoid buy-writing if the market shoots north, but that didn’t happen save for a few good weeks in early July. So, as it turned out, over-writing worked like a charm as you got extra income without giving away any upside.

�

Another way to view this is to look at 30-day implied volatility (the VIX, more or less) versus 20-day realized (historical) volatility (the SPX itself) over the same three months.

Lagged Correlation vs. HV 20-day and IV Index 30-day

And as you can see, 30-day implied volatility (IV) has not moved all that much. It spiked into the high 30s in late May, but quickly gave it back and has gravitated near 25. Meanwhile, historical volatility (HV) simply trended lower. It started around 28 and now sits at about 16.

Now that we have a handle on the past, what about the future?

Consider this: Options are currently trading at a nice premium to realized volatility — about 7 volatility points rather than the typical 4 points or so. And VIX futures think options are too cheap. October VIX futures closed near 32, about a 6.5 point premium to the VIX.

This is not a perfect comparison, as the VIX incorporates out-of-the money (OTM) puts that ramp up the number a bit. But even so, an October VIX future at 32 implies that Mr. Market expects downtrending realized volatility to virtually double in the next two months. Volatility almost always picks up after summer, but that’s a rather extreme expectation.

Follow Adam Warner on Twitter @agwarner.

Daily Trader�s Alert: Red-Hot Trades Sent Right to Your Inbox! – Complete with chart and trading target, this daily stock or ETF pick is e-mailed to you each trading day before the market open. InvestorPlace�s Chief Technical Analyst Sam Collins also gives you his take on what’s slated to impact your portfolio during the trading day. Click here to subscribe to the Daily Trader�s Alert — it�s FREE!