CBOE - Hedgers Beware: The VIX’s Muted Volatility In 2022 May Warrant A Strategy Change
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Dispersion trading isreturning to the markets amidst a timid response to market uncertaintyfrom Cboe’s Volatility Index™ (INDEXCBOE: VIX).
The trading strategy isbased on the underlying difference between the implied volatility ofS&P 500 Index options and the “actual” volatility observed. In2022, market conditions were ideal for dispersion trading. Speaking of2022, Scott Phillips of Lavaca Capital says :“The lack of a meaningful increase in implied volatility this year,despite a large market sell-off, is quite unusual.”
Phillips highlights that the VIX index’sclose of 28.71 on June 30, 2022, was nine points, or 23%, lower thanthe average close compared to historical declines dating back to 1993.This discrepancy occurred during a period of heightened swings in theprice of U.S. large-cap stocks, an aggressive monetary tighteningstrategy from the Fed and geopolitical tensions in Eastern Europe. TheVIX had many reasons to reflect meaningfully heightened volatility,but it did not.
Opportunities And Pitfalls Of Discrepancies InImplied And Realized Volatility
Market participants have pondered the causes ofthis discrepancy, but a topic perhaps more worthy of investigation iswhat to do about its existence. Some nimble money managers employingdispersion trading, for example, reaped double-digit returns in 2022,while the market tanked by roughly 20%.
These traders recognized that marketconditions favored selling options contracts in indices while buyingoptions contracts in individual stocks. The rationale for thisbehavior arises from the known fact that the difference between implied and realized volatility in indexoptions is greater than in individual stock options.
The discrepancy also has an impact ontraders who use options to hedge against their portfolios. Phillips summarizes the bottom line for these traders: “Because of the lack of animplied volatility in 2022 relative to what has occurred in similarhistorical market drawdowns, those using put options to hedge adownside move in the S&P500 likely did not get the response theywere looking for from their options hedges.”
Cboe Extends VIXOptions Availability To 24 Hours A Day, 5 Days A Week
While the discrepancybetween implied and realized volatility has shrunk since mid-2022,there’s no telling when this discrepancy may arise in the future.
Discrepancies inthe market, especially those that are statistically significant andrelatively unknown, can grant traders unique edges over theircompetitors. Cboe aims to improve the accessibility to these momentsand offers expanded global trading hours (GTH) for VIX options inorder to meet this goal.
Globaltrading hours (GTH) regime began on April 25th, 2022, and incorporatesa brief “curb trading session,” a time period following regulartrading hours where market participants can adjust, unwind, or closetrades. Under this regime, traders from across the globe canparticipate in options trading strategies and engage in the pursuit ofalpha.
Find outhow you can turn volatility into your advantage here .
This article was originally published onBenzinga here .
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