With the VIX index back below 10, it’s only natural for people to be asking, is that justified? Should volatility really be this low?
Yesterday I showed that chart of the 30 lowest VIX Index closes in history and 22 of the 30 were in the last few months. But implied volatility isn’t the only way to view how calm the markets are.
Implied volatility (IV) is the markets forward estimate of a security’s price. In the case of the VIX Index it’s a forward estimation of future S&P 500 prices.
Historical volatility (HV) is the realized volatility over a specified time period. The most commonly quoted is HV20, and it’s the one I mostly use as well, which is the realized volatility over the previous 20 trading days.
So yesterday’s VIX chart clearly shows that the markets forward estimation of S&P 500 prices is as low as it’s ever been, but is it justified? Let’s look at historical vol:
Considering the realized volatility is also hovering around historical lows, at least from a mathematical perspective the answer is yes. A VIX of 10 makes sense right now.
There’s going to be plenty of people who “feel” like a VIX of 10 is too low given the geopolitical scene right now, the gridlock in Washington, the Fed beginning it’s balance sheet unwind, and to be honest I’m one of them. There’s all kinds of reasons why it feels too low, but from a mathematical perspective it does make sense.
If the markets aren’t moving, there’s no reason to price in elevated forward volatility. The IV30 is already twice as high as HV20 which is a very large spread. Now of course that can change in an instant, but for right now the investing world still makes sense.
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