{"id":190597,"date":"2023-05-18T12:45:00","date_gmt":"2023-05-18T16:45:00","guid":{"rendered":"https:\/\/ibkrcampus.com\/?p=190597"},"modified":"2023-05-18T12:57:16","modified_gmt":"2023-05-18T16:57:16","slug":"asymmetric-risks-and-vix","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/securities\/stocks\/asymmetric-risks-and-vix\/","title":{"rendered":"Asymmetric Risks and VIX"},"content":{"rendered":"\n<p>If you watch enough bad television or ancient re-runs (like me), it is inevitable that you will see advertisements for insurance products like Colonial Penn and Car Shield.&nbsp; Thanks to my decades as an options market maker, I have always paid extra attention to insurance commercials.&nbsp; In that role, I considered myself to be an insurance underwriter \u2013 not for life or auto, of course, but for financial risks.&nbsp; I bring up the topic today because insurance is most useful for hedging asymmetric risk, and that is exactly what we face today.<\/p>\n\n\n\n<p>Insurance is most necessary when someone faces a low probability, high outcome event.&nbsp; The odds of one\u2019s house catching fire on a given day is quite low, but it would be a catastrophe if it occurs.&nbsp;&nbsp; So, we buy fire insurance and hope that the premiums are wasted expenses.&nbsp; I would assert that the debt ceiling creates a similar type of event.&nbsp; There may a low probability that a default occurs, but one would be a high outcome catastrophe.&nbsp; Although the risk of financial arson exists, <a href=\"\/campus\/traders-insight\/securities\/macro\/dont-fire-until-you-see-the-whites-of-their-eyes\/\">we\u2019ve also noted<\/a> that equity investors are generally taking the view that we\u2019ve skirted this risk before so it\u2019s not worth worrying about now.&nbsp;<\/p>\n\n\n\n<p>But not all investors are completely sanguine.&nbsp; The significant volume and open interest in upside VIX calls expiring in June tell us that some are buying insurance policies, just in case.&nbsp; So far this morning, over 150,000 VIX 30 strike calls expiring June 21<sup>st<\/sup> have already traded on a line with over 550,000 open interest.&nbsp;<\/p>\n\n\n\n<p>Yesterday\u2019s rally reinforced the notion that an agreement may be in sight, which may be why the bulk of the calls mentioned above traded on the bid side.&nbsp; A holder may have decided that insurance is less necessary today than previously.&nbsp; Yet the buy-the-rumor, sell-the-news aspect of markets may offer an even greater rationale for hedging now.&nbsp; For one, it\u2019s cheaper today.&nbsp; For another, if a greater probability of success gets priced in, it increases the impact of failure.<\/p>\n\n\n\n<p><a href=\"https:\/\/www.youtube.com\/watch?v=btzboPlISD4\">I was asked recently<\/a> if VIX was too high or too low.&nbsp; Quite frankly, if this was a high school debate I could reasonably take either side.&nbsp; Let us start with a piece of visual evidence:<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><strong><em>2-Year Chart: SPX Historical Volatility, 10-Day (yellow), 30-Day (orange); Implied Volatility (white); SPX Level (faint grey)<\/em><\/strong><\/h3>\n\n\n\n<figure class=\"wp-block-image size-full\"><img decoding=\"async\" width=\"624\" height=\"425\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/05\/Picture2-11.png\" alt=\"2-Year Chart: SPX Historical Volatility, 10-Day (yellow), 30-Day (orange); Implied Volatility (white); SPX Level (faint grey)\" class=\"wp-image-190600 lazyload\" data-srcset=\"https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/05\/Picture2-11.png 624w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/05\/Picture2-11-300x204.png 300w\" data-sizes=\"(max-width: 624px) 100vw, 624px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 624px; aspect-ratio: 624\/425;\" \/><\/figure>\n\n\n\n<p><em>Source: Interactive Brokers<\/em><\/p>\n\n\n\n<p><em>If we assert that VIX is too high?<\/em>&nbsp; If we look at the historical volatility of the S&amp;P 500 Index (SPX) on either a 10-day or 30-day basis, we see that it is quite depressed.&nbsp; Both are just about 10% on an annualized basis.&nbsp; That shouldn\u2019t be too much of a surprise; <a href=\"\/campus\/traders-insight\/securities\/stocks\/taco-tuesday-widening-wednesday\/\">as we noted yesterday<\/a>, SPX was almost exactly unchanged on a quarter-to-date basis as of Tuesday\u2019s close.&nbsp; If you believe that we will remain mired in the current trading range, then a VIX level of 16.60 seems high.&nbsp;<\/p>\n\n\n\n<p><em>If we assert that VIX is too low? <\/em>&nbsp;If you believe that there is a reasonable chance for a stumble along the way to a debt deal, let alone a default, then VIX has plenty of room to run and run quickly.&nbsp; We have seen a couple of quick spikes on relatively minor downdrafts, as the chart below shows.&nbsp; On Monday, May 1<sup>st<\/sup>, when VIX touched 15.50, we wrote that <a href=\"\/campus\/traders-insight\/securities\/macro\/the-calm-before-the-calm\/\">markets felt eerily calm<\/a>.&nbsp; By Thursday, VIX traded over 21.&nbsp; When implied volatilities are at relatively low levels, they tend to rise abruptly at even modest signs of trouble.&nbsp; And as the chart above shows, the last time historical and implied volatilities were this low was the late 2021 &#8211; early 2022 period when major indices topped out.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-vix-20-day-chart-15-minute-bars\"><strong><em>VIX 20 Day Chart, 15-Minute Bars<\/em><\/strong><\/h3>\n\n\n\n<figure class=\"wp-block-image size-full\"><img decoding=\"async\" width=\"624\" height=\"331\" data-src=\"\/campus\/wp-content\/uploads\/sites\/2\/2023\/05\/Picture1-27.png\" alt=\"VIX 20 Day Chart, 15-Minute Bars\" class=\"wp-image-190599 lazyload\" data-srcset=\"https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/05\/Picture1-27.png 624w, https:\/\/ibkrcampus.com\/campus\/wp-content\/uploads\/sites\/2\/2023\/05\/Picture1-27-300x159.png 300w\" data-sizes=\"(max-width: 624px) 100vw, 624px\" src=\"data:image\/svg+xml;base64,PHN2ZyB3aWR0aD0iMSIgaGVpZ2h0PSIxIiB4bWxucz0iaHR0cDovL3d3dy53My5vcmcvMjAwMC9zdmciPjwvc3ZnPg==\" style=\"--smush-placeholder-width: 624px; aspect-ratio: 624\/331;\" \/><\/figure>\n\n\n\n<p><em>Source: Interactive Brokers<\/em><\/p>\n\n\n\n<p>Given what I said earlier about the importance of insurance in protecting against low probability, high outcome events, you should be able to figure out which side of the debate I find more appealing.&nbsp; The latest rhetoric from D.C. has been positive, but a deal remains murky.&nbsp; When we consider that equity markets have not sold off in response to default fears, it seems reasonable to think that they won\u2019t rally much if an agreement is reached.&nbsp; In a one-tailed risk scenario, it is often prudent to purchase insurance.&nbsp; As with your homeowners policy, you may not want the insurance to pay off, but it may help you sleep better at night.&nbsp;<\/p>\n\n\n\n<p>For further reference about the similarities and differences between conventional insurance and listed options, please read this piece from August 2021:&nbsp; <a href=\"\/campus\/traders-insight\/financial-education\/moral-hazard-insurance-and-options\/\">Moral Hazard, Insurance, and Options | Traders&#8217; Insight (www.interactivebrokers.com)<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"<p>When I was an options market maker, I considered myself to be an insurance underwriter \u2013 not for life or auto, of course, but for financial risks.  I bring up the topic today because insurance is most useful for hedging asymmetric risk, and that is exactly what we face right now.<\/p>\n","protected":false},"author":4,"featured_media":161790,"comment_status":"open","ping_status":"closed","sticky":true,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[14700,6,8,9,22,26,3],"tags":[207,317,860],"contributors-categories":[13576],"class_list":{"0":"post-190597","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-ibkr-market-insights","8":"category-north-america","9":"category-region","10":"category-securities","11":"category-stocks","12":"category-text-articles","13":"category-traders-insight","14":"tag-spx","15":"tag-vix","16":"tag-volatility","17":"contributors-categories-interactive-brokers"},"pp_statuses_selecting_workflow":false,"pp_workflow_action":"current","pp_status_selection":"publish","acf":[],"yoast_head":"<!-- This site is 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