Barclays Sees VIX Rebound With Risk Premium at Bull Market Low

  • Spread between VIX and realized volatility smallest since 2009
  • The volatility gauge has slipped 60 percent since August rout

The U.S. stock market is quiet -- too quiet.

One example is the price investors are paying for options on the Standard & Poor’s 500 Index, a value that is captured by the Chicago Board Options Exchange Volatility Index. At present, options dealers are charging so little for protection in equities that the VIX is trading at a six-year low compared with the actual volatility of the benchmark gauge.

That’s not a good sign to Barclays Plc derivatives strategist Maneesh S. Deshpande, who sees the potential for the VIX to snap back from its recent slide. Deshpande says not enough has changed in China or with the Federal Reserve’s rate-hike schedule to spur this much calm among equity investors, especially with earnings season just getting started.

Barclays sees VIX rebounding as this measure normalizes
Barclays sees VIX rebounding as this measure normalizes

“There’s still some noise globally, so realized volatility should stay relatively high,” said Deshpande in a phone interview. “The VIX is just not high enough when you compare the two, and it needs to make up the difference. The risk premium is too narrow.”

Options indexes like the VIX are subject to a hodgepodge of influences, first among them the recent price history of the asset they track, a value known as realized volatility. The other big input is investor sentiment: when investors are worried, dealers charge more. Deshpande’s point is that complacency among investors has been restored so fast that the VIX sits closer to its realized volatility than at any time since the bull market began.

After spiking to the highest in almost four years during the S&P 500’s summer swoon, the VIX has tumbled more than 60 percent as the benchmark equity index rebounded. The volatility measure has been below 20 for 12 straight days. Prior to that, it traded above that level for 30 sessions, the longest such streak since January 2012. The gauge rose 6 percent to 16.70 at 4:15 p.m. in New York.

Hedge funds and other large speculators are wagering that U.S. equity volatility will increase. There were 15,639 net long positions tied to the VIX, according to the latest weekly data from the U.S. Commodity Futures Trading Commission. That’s the eighth straight week the numbers have reflected a bullish stance toward volatility going back to the depths of the summer selloff. Prior to that, net positions had been short for every week since February.

Even amid this positioning and Deshpande’s call for a higher VIX, the benchmark volatility gauge is in line with historical values. Since the start of 2012, the VIX has traded at an average of 15.67, within 0.7 percent of its current level.

Deshpande is also keeping an eye on third quarter earnings as companies provide forecasts for the end of the year and into 2016. That will provide clues on the strength of corporate America amid slowing growth in China and as the Federal Reserve considers raising interest rates for the first time in almost a decade.

“The forward guidance from companies will be more important than usual,” said Deshpande. “That should also keep realized volatility reasonably high.”

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