Volatility Curve Suspiciously Quiet Leaves Analysts on Edge

(Bloomberg) -- All the churn in U.S. equities of late has done little to knock relationships in the volatility market out of whack -- and that worries some strategists.

Take the VIX curve, which compares the main index of equity turbulence today to levels priced into the market weeks and months down the line. Normally in times of chaos the arc inverts, as volatility in the here and now surges above levels implied by futures. This time, it’s holding steady.

Volatility Curve Suspiciously Quiet Leaves Analysts on Edge

To analysts who believe market swings since Friday are just the first step toward a more normal level of volatility in stocks, persistent balance in VIX futures suggests a market that has yet to exhaust itself of selling.

“So far what we’ve seen barely even shows up on the radar,” Jim Strugger, a derivatives strategist at MKM Partners in Stamford, Connecticut, said by phone. “Volatility between these shocks has been oddly low but we’re still in a high-vol regime -- what this makes me think is we have a long way to go. There are no rules to define what a shock is, but as far as I’m concerned, if spot VIX doesn’t get toward 25, this is just rumblings.”

A decline of 2.6 percent in the S&P 500 Index since Thursday has sent the VIX, largely dormant through the months of July and August, up 45 percent in the past four trading days. The gauge of options prices closed Wednesday at 18.14, the highest level since June, after reaching a two-year low of 11.3 a month ago. It slipped 3 percent by 11:27 a.m. in New York.

Even after the surge, the VIX remains below its 10-year average of 20.6, and moves in futures contracts tied to the gauge are even less impressive. While the contract expiring in September jumped 37 percent, contracts in October and November are up less than 20 percent from a week ago.

Those moves pale in comparison to other recent bouts of stock-market turmoil. The VIX futures curve inverted in the days after the U.K.’s Brexit vote in June and at the peak of selling in February. In August 2015, the VIX was 11 points higher than the first month futures contract.

“Regarding the VIX futures curve, part of the reason why inversion hasn’t happened yet is the fact that the VIX hasn’t risen enough,” Anand Omprakash, an equity derivatives strategist at BNP Paribas SA in New York, said in an e-mail. “Generally, we see the curve invert near the 19 or 20 handle. All of the futures move higher when the VIX rises, but the longer-dated futures have a lower beta.”

A calm VIX futures market is ointment for the sting felt yesterday by institutional investors like hedge funds that last month built up the biggest short position in VIX futures on record. While the price jump in short-term contracts is a mark against that bet, it’s the futures contracts that matter to hedge funds betting on lower volatility.

Investors shorting volatility are unlikely to change their stance even after the selloff, partially because they’ve made so much on it so far, according to Macro Risk Advisors’ Pravit Chintawongvanich. Since the S&P 500 bottomed on Feb. 11, an exchange-traded note tracking short-term VIX futures is down 66 percent.

“People probably lost money but I don’t think anyone is forced to cover yet,” said Chintawongvanich, head derivatives strategist at New York-based MRA. “They know it’s not going to last forever but at the same time imagine how much it hurts to be long VIX. Looking at the spot VIX doesn’t reflect the performance.”