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VIX, a la Mode

Reverting to the Mean 


May 3, 2017

The VIX (an index that shows the market’s expectation of volatility) has spent the past five months trading mostly between the 10 and 13 handles. I’ve been fielding many questions about why the VIX is so low and if that signifies ‘complacency’.
In fact, I don’t think ‘complacency’ and the VIX should be used in the same sentence. While most people refer to the VIX as a mean-reverting product, it actually isn’t  – at least not in any useful sense of the term. As always with derivatives, it’s wise to not necessarily take things at face value. Let’s revisit some high school math: The mean is the average, and the average of the VIX over the last 20 years is indeed at about 20. The median is the very middle sample of observations, so in this case, it’s about 18. The ‘mode’ is where the most observations are found, and in this case, it is about 13. 
So ‘normal’ isn’t in fact anything close to 20. Over the last 20 years, the majority of VIX observations have been in the low teens. That is something we should be very aware of. When we are looking to buy or sell volatility, we must be cognizant of the fact that option prices can stay low for a very long time – the mode tells us so. It doesn’t mean that the VIX can’t go up, because it absolutely can – but I like to see this low range of VIX as muted and approaching normal, rather than complacent.
If the market was swinging around and the VIX was whipping from 14 to 18 and back again – then yes, I would say 13 is cheap. Right now, however, realized movement is tiny. Remember how averages work: Large VIX spikes can ‘skew’ the mean number drastically upwards. Think of it this way: Imagine you’re walking across the Sahara and the sand is mostly flat. Suddenly you come across a great pyramid. What will stand out in your mind forever is the magnificent sight of the pyramid, and not necessarily the mass of level sand around it. When the VIX is at 40, it is the pyramid, but a great deal of the time it’s just flat terrain. Watching the VIX can be fun, but be careful with how you interpret the level.
The views/opinions expressed herein may not necessarily be the views of AlphaPro Management Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.

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