Beware Calm Surface Waters

By Craig Basinger, CFA

Earlier this week, the VIX Index, which measures U.S. equity market volatility, moved below 10. Crazy, eh? The VIX measures the implied market volatility being priced into a basket of call and put options on the S&P 500. Or, you can simply think of it as expected market volatility, based on the cost of options. Dropping below 10 has only occurred a few times in the history of the VIX that dates back to 1990. It happened in 1993, late 2006 / early 2007 and now in 2017 (chart). We could provide a narrative as to why the VIX is low. Perhaps too much liquidity in the market is supressing volatility (vol). Still, sub 10 is very rare and worth noting.

The good news is that while a very high VIX is often viewed as a buying opportunity, the opposite is not necessarily true. Volatility can remain depressed or below the historical average for an extended period of time. And during these times, the markets often march higher. Following 1993, when the VIX dipped below 10, we saw markets march higher for the next seven years. Conversely, early 2007 would have been a good exit point. Worth noting, the VIX brushed against the 10 level many times from 2004 till 2007, as markets enjoyed a strong advance.

Canada also has a VIX measurement, based on TSX 60 options. It does have some weird pricing on occasion, likely due to our fragmented options market. But generally speaking, the Toronto VIX (TVIX) appears to be at or near the bottom end of its range. This got us wondering whether it was really capturing the volatility of the market. In the past two weeks, we have seen some fairly big price moves. Home Capital fell 60% in one week, Aimia is down 55% this week. These are unique situations, but the market just felt more volatile than the TVIX was showing. So we did some more digging.


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