Tuesday, September 1, 2009 at 01:03PM | Asher Pinto
Despite the fact that the markets have rallied over 50% since the lows and the action has been relatively slow over the past few weeks, the VIX is trading at a level of around 25.
For a few weeks now, we've been a little perplexed by the fact that implied volatility levels are seemingly irrationally high; thereby making options more expensive to purchase than they perhaps should be.
The intuition that implied volatility levels are too high, given the relatively quiet action seen over the past two months or so, is backed by evidence provided in the chart below. It provides a comparison of 30-day historical (actual) volatility on the S&P-500 index with the implied volatility index on the S&P-500.
You'll notice that the IV index, which is similar to the more popular VIX, is trading at around 21-22%, while 30-day historical volatility is trading at around 15%. Implied volatility typically trades at around the level of actual volatility; the exception is during extreme periods (see Oct-Dec '08).
However, one would imagine that the present juncture cannot be characterized as one of extremes. Yes, there has been a relatively large rally from the lows, but it has been mostly a steady and measured climb. This has been true especially over the past two months or so.
So why are implied volatility levels as much as 6-7 percentage points higher than actual volatility levels?
The VIX is often called the "investor fear guage." With IV levels being considerably higher than they should be, it would be safe to say that there still seems to be a relatively high level of fear (of a bearish turnaround) in the markets.
What does this mean, as far as traders are concerned? Well, implied volatility is mean-reverting, as the chart shows. So traders will now be wondering whether implied volatility is going to fall to more sensible levels or actual volatility levels rise to that of IV.
If the latter takes place, it will presumably come with a sharp bearish turnaround in the markets and the high IV levels will finally "make sense." We'll provide an updated look at the IV vs HV chart in the commentary pieces in the Members Area, every couple of days.
« Wide Spread between Actual and Implied Volatility »
Despite the fact that the markets have rallied over 50% since the lows and the action has been relatively slow over the past few weeks, the VIX is trading at a level of around 25.
For a few weeks now, we've been a little perplexed by the fact that implied volatility levels are seemingly irrationally high; thereby making options more expensive to purchase than they perhaps should be.
The intuition that implied volatility levels are too high, given the relatively quiet action seen over the past two months or so, is backed by evidence provided in the chart below. It provides a comparison of 30-day historical (actual) volatility on the S&P-500 index with the implied volatility index on the S&P-500.
You'll notice that the IV index, which is similar to the more popular VIX, is trading at around 21-22%, while 30-day historical volatility is trading at around 15%. Implied volatility typically trades at around the level of actual volatility; the exception is during extreme periods (see Oct-Dec '08).
However, one would imagine that the present juncture cannot be characterized as one of extremes. Yes, there has been a relatively large rally from the lows, but it has been mostly a steady and measured climb. This has been true especially over the past two months or so.
So why are implied volatility levels as much as 6-7 percentage points higher than actual volatility levels?
The VIX is often called the "investor fear guage." With IV levels being considerably higher than they should be, it would be safe to say that there still seems to be a relatively high level of fear (of a bearish turnaround) in the markets.
What does this mean, as far as traders are concerned? Well, implied volatility is mean-reverting, as the chart shows. So traders will now be wondering whether implied volatility is going to fall to more sensible levels or actual volatility levels rise to that of IV.
If the latter takes place, it will presumably come with a sharp bearish turnaround in the markets and the high IV levels will finally "make sense." We'll provide an updated look at the IV vs HV chart in the commentary pieces in the Members Area, every couple of days.