Vol of Vol: Scouting VVIX
Sep 25, 2017
The current paradigm in volatility trading reads as follows: "Volatility pops slightly, volatility gets hammered. Repeat."
In the last year, the VIX has risen above its historical average of 19 only once, and that was right around the time of the US Presidential election in 2016. So far in 2017, the VIX hasn't broken through 19 a single time.
Given these conditions, it shouldn't surprise anyone that premium sellers have been winning. In fact, savvy premium sellers have been doing pretty well since the market bottomed in 2009.
The familiar trading pattern in volatility over recent months, combined with the absolute low levels of the VIX, has raised the profile of strategies that perform well under these conditions. However, it's critical to remember that the past is never a perfect predictor of the future.
While it's great to be aware of approaches and products that have been utilized to leverage low volatility conditions, it's also important to closely evaluate whether they are suitable for your own approach and risk profile, before jumping in.
For traders that are looking to learn more about volatility products beyond the VIX, a recent episode of Options Jive is a good place to start. This particular episode focuses on the VVIX, and its relationship to the aforementioned "regular" VIX.
The VIX, as most are already aware, is calculated using the implied volatility of options in the S&P 500. As implied volatility rises in S&P 500 options, so too does the VIX.
Alternatively, the VVIX is calculated using the implied volatility of out-of-the-money (OTM) put options in the VIX itself. The VVIX is often said to measure the "volatility of volatility” (aka "vol of vol”).
Practically speaking, the VIX gauges risk premium in S&P 500 options, whereas the VVIX gauges the risk premium in VIX (downside) options. Consequently, VVIX provides further insight to traders on the current trading environment.
Thinking through the mechanics of the VIX and VVIX, it stands to reason that as the VIX rises, the VVIX should also go higher (and vice versa). Thanks to Options Jive, we can see this relationship in historical chart form, as shown below:
If you are wondering why the two don't always move together, imagine the following hypothetical situation. If VIX were to spike to 45 over the course of a couple weeks, we can safely assume VVIX would also make a big move up.
Now imagine that VIX dropped from 45 to 43. It's possible that implied volatility in VVIX would not drop to the same degree, given that VIX at those lofty levels would still be well above its historical average. The implied volatility in VIX puts might remain firmly bid (i.e. a high VVIX value), given that VIX could still drop precipitously.
That’s just one example of a situation in which VIX and VVIX wouldn’t move in perfect unison. According to recently published tastytrade research, that happens roughly 24% of the time - combining the second and third bullet points below:.
VIX up, VVIX up: 34%
VIX up, VVIX down: 13%
VIX down, VVIX up: 11%
VIX down, VVIX, down: 42%
Adding together the first and fourth bullet points above equates to approximately 76% of the time that VIX and VVIX move together.
At this point, we have outlined in greater detail VIX and VVIX, as well as the typical relationship between the two. Now, we can take our thinking to the next level, and apply these learnings to practical trading situations.
If you are trading VIX, an awareness of VVIX may help you optimize your approach across different volatility environments. The chart below shows how movement in both the VIX and VVIX can affect a variety of positions in the VIX:
The above breaks down the nuances of trading VIX options, and includes the potential impact of movement in VVIX on each type of position.
Given that the VVIX has traded with a median of roughly 86-87 (ranging between about 60 and 145) in recent years, traders can monitor ongoing levels in VVIX and use those reference points as another input in the trading decision-making process.
For example, imagine that VIX and VVIX are both trading near the higher end of their historical ranges (well above the mean). Hypothetically speaking, let’s say the VIX is 40 and VVIX is 135.
Looking at the chart above, a trader might be more likely to consider deploying a credit call spread in this type of trading environment, because the potential for both VIX and VVIX to revert toward their historical means is fairly high.
On the other hand, if both VIX and VVIX are trading at the lower end of their historical ranges (for example VIX = 10 and VVIX = 65), then traders might consider deploying a long call in the VIX, as that position performs well when both VIX and VVIX rise.
No matter your particular strategy or approach, the VVIX is a metric that all volatility traders should keep on their radar. Like a canary in a coal mine, movement in the VVIX can serve as an additional alert system that calls attention to important changes in the volatility environment.
We hope you’ll take the time to review the complete episode of Options Jive focusing on the VVIX when your schedule allows. For more information on the VVIX, tastytraders can also review a previous installment of Market Measures.
If you have any questions on volatility products such as VIX or VVIX, we hope you’ll reach out directly to email@example.com at your convenience.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
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