Manic Monday VIX

• Posted by Adam Warner
• on July 19th, 2010

Notice that VIX up big, with VXX down a smidge? Hey, it’s the long lost Monday Effect! Odd that it happens after such an ugly Friday. Was anyone that worried about eating weekend decay after a market melt? I guess so.

Anyway, MKM Partners has some thoughts on the volatility picture.

The 2.9% dive in the S&P 500 Index on Friday produced a benign 4.4% increase in spot VIX to 26.25, with a late-day swoon likely attributable to pricing-in a summer weekend. Meanwhile, the VIX futures term structure remains historically steep with a 6.8 point spread between spot and the 6-month futures. This seemingly divergent view between near- and longer-term equity market risk has fueled increasing debate recently. As a result, we want to reiterate our thesis.

Our view is that U.S. equity markets are in the midst of a high-volatility cycle that will last another two years if the duration of prior regimes is matched. This suggests a floor for spot VIX in the 15-18 range and ceiling, based on the most recent aftershock, around 45. Since that peak on May 20, spot VIX has vacillated around the trendline established by the volatility shocks in the 1997-2003 period that we continue to view as the relevant analog (above graph with each cycle peak indexed to P=0). Based on this benchmark, we expect spot VIX to remain elevated for a few more weeks before slipping sustainably down through 25 which will mark the end of this aftershock, in our view. In this scenario, spot VIX would test the low end of the long-term

However, within the context of a high-volatility cycle, spot VIX at the low-end of its range represents complacency that will be only temporary. Given the historical mid-October peak in implied volatility our eyes will be on that period for the next aftershock.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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