The CBOE VIX Volatility Index: S&P 500 Expected 30-Day Volatility. Is US Equities Volatility Fairly Priced Relative to Financial Market Proxy?

Thanks again to everyone for reading my newsletter earlier this week. I look at the VIX index (S&P 500 expected volatility) often and usually get some comments on posts about it. I thought I’d share a more comprehensive look at various VIX metrics. I’ll provide additional context below, however at the highest level VIX was introduced in 1990 and is commonly considered a gauge of expected 30-day in the S&P 500. Its value is calculated daily by averaging the weighted prices of a specific group of S&P 500 call and put options. The underlying principle behind this calculation is the greater the premium on VIX options, the more uncertainty investors have about the direction of the market.

MOVE is a US bond market volatility estimate index by BAML, frequently used as a proxy measuring US bond market volatility relative to VIX as US equity market volatility. From the chart below demonstrating the 20-year relationship, you’ll note VIX has been consistently underpriced relative to MOVE in the recent market cycle. One way to interpret that is investors in the bond market are more concerned about potential market risk than US equity market participants. For perspective, VIX peaked at 79.13 while MOVE peaked at 264.60 during the thick of the 2008 GFC. In my view, both may be underpriced today, as the fixed income market has been deteriorating for numerous reasons. Historic public debt levels, an extreme oversupply of US Treasury issuances resulting in auction failures, & a re-emergence of inflation, just to name a few.

The Chicago Fed’s National Financial Conditions Index (NFCI) provides a comprehensive weekly update on U.S. financial conditions in money markets, debt and equity markets, as well as the traditional & “shadow” banking systems. Since the inception of the VIX index in 1990, the two appear to have a high correlation. Even though the NFCI is currently in contractionary territory at -0.38, VIX appears to still be underpriced on a relative basis.

Some might also argue high yields (“junk bonds”) can be used, to some extent, as a bond market proxy relative to VIX. This metric similarly seems to indicate the US equity market is complacent relative to the US bond market. I believe it’s quite possible high yields may be underpriced in the environment. BAML’s high yield index was very recently at 9.2% in this reading, while the current 2YR US Treasury yield is 4.993%. High yield bonds indices don’t carry any bonds rated above BB, so it really depends on your risk appetite. I’m not convinced the positive delta [+4.207%] for high yields is enough compensation for such a huge gap in market risk.

Taking the ratio of VIX/MOVE, the recent level observed in the below chart confirms the US equity market hasn’t been this complacent relative to the US bond market in over 20+ years, since mid-2003. One might argue there was good reason for US equities participants not to be unconcerned about volatility at the time, as we were in the post-tech bust secular bull market in US equities.

EVZ is another asset class volatility index offered by CBOE, generally considered the FX market proxy to VIX. It appears EVZ and VIX have been mostly moving together in this recent market cycle.

A look at the three volatility indices for equities, bonds, & FX – VIX, MOVE, & EVZ – beginning in the post-GFC era to today.

As mentioned briefly, different US equity market indices have their own expected volatility indices. VXN is a measure of expected NASDAQ 100 volatility, RVX – the Russell 2000, & again VIX correlates to the S&P 500. From my perspective, VXN (NASDAQ 100 volatility) is correctly priced elevated to the other two given price action in the US equity market. I also think it’s interesting that since late 4Q22 when the bear market reversed post-ChatGPT, VIX has seemingly been trending substantively lower than RVX (Russell 2000 volatility). The Russell 2000 is up a very modest +0.20% YTD, while the S&P 500 is up +13.59% this year, which could be one explanation. That wouldn’t be confirmed by VXN, as it seems to be the most elevated of the three on a relative basis, despite the NASDAQ 100 up +38.07% YTD.

CBOE also offers the VVIX index, which is often referred to as the ‘VIX of VIX’.? VVIX is the expected 30-day volatility of VIX. Specifically, it’s a measurement of expected 30-day volatility of expected 30-day volatility in the S&P 500. Hence the nickname the ‘VIX of VIX’. Intuitively, if the expected volatility of VIX rises, more often than not the reading for VIX rising is not far behind. However, it’s crucial to understand these are two separate measurements and therefore you’ll note quite a few instances where VVIX rising does not result in VIX moving substantively. VIX rising is certainly much more closely linked to a potential volatility event in the S&P 500. I believe it’s fair to suggest the value of VVIX might give investors a clue as to where VIX could be heading. For reference, I noted some recent significant events when VVIX, VIX, or both spiked.

The VVIX/VIX ratio is a measure that allows investors to compare relative volatility in the US equity market. As a ‘rule of thumb’, the VVIX/VIX ratio rising upward indicates increasing complacency in the US equity market, while the ratio of VVIX/VIX falling suggests a potential volatility event is becoming more likely. For reference, this measurement peaked at 10.18 in October 2017, during relaxed market conditions during the post-GFC US equity secular bull market. It observed a trough in November 2008 at a reading of 1.37, roughly a month after Lehman went insolvent and US equity market participants capitulated in really dramatic fashion.

Perhaps a bit unintuitive at first thought, bank lending standards tightening, to an extreme degree in particular, have a noteworthy historic correlation to VIX volatility. The fundamental reason behind this is when bank lending standards rapidly tighten, history suggests credit market deterioration is expected in the near to mid-term. In the last SLOOS [Senior Loan Officer Opinion Survey] report on bank lending standards, we observed exactly that. Bank lending standards have now tightened to recession-only levels dating back at least four cycles. From an expected volatility perspective, US equities currently appear to have the highest investor confidence of any asset class.

Final couple thoughts I wanted to share as it relates to VIX I’ve touched on previously. CBOE introduced varying intervals of VIX options over time and they combine to cumulatively calculate the popularized VIX S&P 500 volatility index. The following intervals of VIX options are available: 1DAY VIX, 9DAY VIX, “VIX” [30DAY VIX], 3MONTH VIX, 6MONTH VIX, & 1YEAR VIX.

The first chart shows VIX as the solid line and the two shorter-term VIX options intervals: 1DAY & 9DAY VIX. It appears when the 2022 US equity bear market reversed upward, initially shorter-term volatility protection via 1DAY VIX was extremely desirable. Since then it’s fluctuated, though market participants seemingly had noticeably increased demand for shorter-term VIX options again during periods earnings actuals were reported.

I also looked at longer-term VIX options (6M & 1YR VIX), as well as 1DAY VIX, relative to the well-known VIX volatility index. From my perspective, it seems like ever since 1DAY VIX options were introduced, which appears to be when the data in these two charts begins, they’ve been the main driving force behind the movements of VIX. More specifically, there seems to either be a very high or very low demand for 1DAY VIX relative to the VIX index. Conversely, 6M & 1YR VIX don’t appear to be weighing on the VIX index close to as much, which I believe reaffirms 1DAY VIX is putting the most price pressure on the VIX index. When the demand for shorter-term options rise, VIX falls. In other words, when you see 1DAY VIX well above the bold red line depicting VIX, it’s pushing it lower than it would otherwise be. On that related note, when 1DAY VIX is below the bold red VIX line, it’s pushing the VIX index up.

Finally, it’s been proposed somewhat frequently in recent times that the S&P 500 trades on VIX. Looking at the first chart over the past year below where VIX is inverted, the correlation seems quite high, implying that this may be an accurate assessment. VIX inverted in this chart suggests when volatility expectations fall, the S&P 500 price rises and vice versa. This seems intuitive, but the longer-term relationship doesn’t have nearly the same kind of correlation. Considering volumes in the options market increased drastically fairly recently, this could be a plausible explanation for this relationship becoming more correlated over time. Or perhaps the popularity of VIX options simply grew considerably.

Either way, it’s hard to argue this relationship looks highly correlated and with VIX often leading. I find the below chart assessing volatility against the S&P 500 is a bit more interesting, though it expresses the same fundamental idea. It’s the two-year relationship between the VVIX/VIX ratio and the S&P 500 price. This similarly suggests when expected volatility rises, the S&P 500 price falls and vice versa.

Just my perspective, but with VIX at a current value of 16.70, downside protection in the S&P 500 seems like it could potentially be a bargain, depending on your investing preferences.

Hope you enjoyed the intra-week read! Please feel free to email me with any questions, comments, feedback, or concerns at:

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Thank you very much again for taking the time to read and I hope this was helpful to some. Happy Friday! Looking forward to sharing my weekend markets overview.

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