Defying what most would consider a fairly uncertain world, the financial market's best-known gauge of volatility continues to drag near 52-week lows.

Although there has been a slight rise in the VIX since it breached 10 for the first time in roughly a decade, the current mark of 11 and change certainly wouldn’t be described as an “explosion” in volatility.

What's even more amazing about the persistent low levels of volatility is the fact that major equity benchmarks in the United States continue to set fresh all-time highs almost daily.

On Friday the 24th of February, 2017 the Dow Jones Industrial Average and the S&P 500 index both hit levels never seen before in history at 20,840.70 and 2,368.26, respectively.

The only certainty is that nobody knows when a paradigm shift might occur.

Having said that, market participants aren't left helpless in the current environment. A recent episode of Options Jive on the tastytrade financial network took a close look at the historical behavior of the VIX once it reaches such notable lows.

As has been discussed previously on the blog, premium sellers obviously prefer to deploy risk when the VIX (or Implied Volatility Rank) is elevated. Such positions allow for exposure to mean reversion, which mathematically supports the fact that in the world of volatility what goes up, must come down (and vice versa).

When implied volatility is high, the extrinsic value (volatility component) of an option's price is higher - which means that the amount of premium received for selling an option is higher. That leaves more room for potential profit, as well as additional protection from fluctuations in the underlying stock price.

In order to better understand the historical behavior of the VIX when volatility does get low, the Options Jive team examined VIX data going back to 1990. The goal was to analyze the frequency and magnitude of VIX moves over the course of 45-day windows, particularly when volatility started to expand.  

Pictured below is a table that summarizes the results of this study. The primary takeaway is that in periods of low implied volatility (i.e. low VIX), 75% of 45 day-windows saw a VIX change of less than 2.5 points:

As you can above, the average expansion in the VIX when it's below 13, isn't that much more pronounced than when the VIX is between 13 and 17, or even above 17.

The one difference that is notable between the three categories in the table above, is how rarely the VIX ends the period lower, when starting the 45 day-window below 13. And the times that it has gone lower, it is by a minuscule amount.

The current lows in volatility have now persisted for an extended period of time. Sellers of gamma and vega since the election of Donald Trump as President of the United States have likely profited in this environment (depending of course on the exact underlying and hedging approach).

There's no way to predict when trading conditions may shift, and to what degree. This suggests that if traders do deploy short premium going forward, they may want to do so through smaller size/scale.

We hope you'll take the time to review the full episode of Options Jive focused on a historical examination of volatility expansion when your schedule allows.

As always, we invite you to reach out at support@tastytrade.com with any questions or comments. Feedback from the tastytrade community is critical to producing the most timely and relevant studies possible.

Happy Trading!


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.