Wednesday, September 7, 2016

"How a Low VIX Can Remain an Expensive Hedge"

From EconompicData, September 6:
One of my favorite Twitter follows @LadyFOHF shared the below scatter chart from Morgan Stanley that attempted to map areas of the global market that were both cheap (valuation ranks at the lower end of its 10-year history) and defensive (a low or negative correlation to global equities).
https://3.bp.blogspot.com/-WYRyMIgAXYU/V8796gMQUEI/AAAAAAAAR-Y/jIE9DD42YpobkGS3YVo0N33WXwpsvyKTwCLcB/s1600/cheapexp.png
One of the few trades listed as having both characteristics was the VIX Index. Let's take a look.

The VIX is Not Investable
The chart below shows the percentile rank of the VIX index over the ten year time frame outlined in the Morgan Stanley chart. The VIX Index was indeed near it's all time low, ranking in the lowest 6th percentile of its ten year history at Friday's close (9/2/16) when the VIX closed at 11.98. 
https://2.bp.blogspot.com/-xIePo4e5dZg/V8798NUAItI/AAAAAAAAR-g/muswiOk5S3E9QDLuoUHQ4XvT-6gXKHGSgCLcB/s1600/VIX%2BRank2.png
But an investor cannot invest in the VIX Index. Rather an investor can buy or sell the consensus view of where the VIX will be, most easily through VIX futures or ETPs (for more details on the VIX term structure, take a look at a past post here).

VIX Futures have Diverged
The below looks at the rank of historical 2nd month VIX futures contract prices (i.e. where consensus views the VIX as being when the 2nd closest VIX future contract matures - which currently makes up the largest holding of VIX ETPs) and we see a different picture....MORE