Jump in hedging costs points to continuing volatility
Just when it looked like Wall Street's fear gauge would settle down for the holidays, it has been on the rise again, and a jump in the cost of hedging suggests that volatility might be here to stay at least until the end of the year.
The spike in the CBOE Volatility Index, which by Tuesday had sent it to a two-month high of 25.2, has come within a span of eight days.
Past surges in the VIX would suggest that it may continue to rise for a few more days.
The surge in volatility in December, usually a calm month for markets, took many by surprise. US equity markets hit new records early in the month, but since then, the sharp drop in oil prices, expectations for the US Federal Reserve to start to indicate plans to raise rates, and turmoil in Russia has brought out sellers.
While the VIX is typically driven primarily by swings in the Standard & Poor's 500 Index, any number of factors could still push the index higher.
"Any really surprising news on oil, Russia or Europe could make the VIX go much higher," said Ophir Gottlieb, chief executive of Los Angeles-based Capital Market Laboratories.
Moreover, measures of the cost of hedging using options on the VIX shows more investors - some caught unawares by the VIX's recent surge - are bracing for further market gyrations.
One way to measure the cost of hedging with VIX options is to look at the VVIX Index, the volatility index for VIX options. On Friday the VVIX touched 141.66, the highest since October 15.
There would have to be considerably more volatility to justify current options prices, BGC Partners equity derivatives strategist Jared Woodard said.
But not all investors are convinced that higher volatility is in the offing. Growing open interest in VIX puts suggests that some traders are beginning to bet the market might start to calm down a bit.
The ratio of VIX puts-to-calls open interest has been on the rise over the past eight trading days. On Wednesday it touched 0.59, the highest it has been this year, according to Trade Alert data. Buying VIX puts is typically a bet on lower volatility.
On average, once spot VIX has risen above the 14 level, it has taken 13 days to peak, said Jim Strugger, derivatives strategist at MKM Partners.
The VIX breached the 14 level on December 8, and Strugger believes it will not peak until around December 24.
