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Someone Is Getting Impatient: The Price Of VIX Convexity Just Hit An All Time High

When it comes to the VIX, it is (almost) safe to say that virtually everything that could be said about the market's record low volatility, its causes, and where it may or may not go from here, has been said. For those blissfully unaware of the market's mind-numbing complacency and boredom, last week the VIX declined 1.68 points during the week of Yellen's unexpected dovish turn, and settled at 9.51, the lowest closing level since December 23, 1993 (and third lowest close of all time), while the ratio of VVIX to VIX increased once again to near its 2-year highs. Additionally, 1m and 1y SPX ATM implied vol fell to 7.1% and 13.3% respectively, each two-year lows. Similarly, 1y correlation among the top 50 names in the SPX also declined to a 2-year low.

For the fanatics, here some additional facts, courtesy of BofA:

  • The VIX has closed 10 times below 10 this year.
    • 1993 had 4 closes below 10
    • 1994 and 2007 each had one
  • It also recorded its third lowest closing value on Friday (the lowest level of 9.31 was recorded in Dec-93).
  • VIX has also closed under 11 55 times YTD with the second closest year being 2006 with 35 such sessions.
  • The volatility index has so far this year traded in the second tightest range (MAX-MIN) of 6.2 vol points.
  • The tightest recorded range was in 1995 when the average VIX level was 0.8 vol points higher.

What is far less known however, is that as VIX has declined to all time lows, bets on a sudden, violent move - in either direction - have soared. Think VIX "Strangle"

As BofA's Benjamin Bowler explains, the 30-day moving average of the ratio of VIX and SPX 1m ATM implied vol reached 1.34 on Friday, July 14, above the 99th %-ile (the max was reached on 26-Jun). In other words, it now trades at a never before seen level. This implies that the price of short-dated equity vol convexity is near all-time highs as the premium the market is assigning to owning the VIX over ATM options is at record high levels. These levels are not surprising considering ATM option prices are at all-time lows and put skew is well-bid by investors as the market remains in a “fragile” state.

Bowler also notes that since the contribution of each option to the VIX’s level is inversely proportional to the square of the option’s strike price (1/K2), the weighting scheme is similar to that of a variance swap, where the most weight is bestowed to the low strike OTM puts. As such, the VIX has embedded convexity.

What the above implies, in simpler terms, is that the market has never before "trusted" the VIX as little as it does now, and has never before been willing to pay, and bet, more for upcoming imminent sharp moves.

Of course, there is nothing suggesting that just because this trade is so popular it will pay off. As we have been showing since 2014, countless investors have piled into various forms of vol gamma and vega, most notably various ETFs and ETNs like going long the VXX or shorting XIV, only to get crushed in a world in which vol no longer exists. On the other hand, at some point the market, as expressed by prices of products such as vol convexity, will be right and the Fed will be stopped out. What happens on that day to either the market, or volatility, remains to be seen.