Low VIX Got You Down? These Fear Gauges May Do the Trick

  • CBOE’s volatility gauge hovers near lowest level since 2014
  • Competing measures show above average investor anxiety

The Competing Ways to Measure Market Volatility

Everything’s fine and calm on Wall Street if you trust the market’s standard fear gauge. Just one problem: the world doesn’t feel so calm these days.

Between an unpredictable political climate, rising interest rates and stretched valuations, there’s building frustration that the CBOE Volatility Index, or VIX, is losing its luster as a reflection of investor anxiety. The measure, which tracks expected volatility through options pricing, sits just two points above its historical low.

Taken at face value, a stubbornly low VIX is flashing signs of complacency, even as some investors fear turbulence ahead. That’s not to say the VIX isn’t functioning how it’s supposed to. It’s a function of realized volatility, not necessarily a sentiment gauge, a read on what traders are willing to pay for options -- the VIX has no emotions, said Dennis Davitt, a portfolio manager at Harvest Volatility Management LLC, which oversees about $9 billion.

“The VIX is what it is: a series of numbers from the S&P 500,” said Davitt, who also helped create Credit Suisse Group AG’s fear barometer in 2009. “It’s like arguing that your gas gauge is wrong. I can yell at it if I want it to be higher, but it’s still going to run out of gas.”

There are plenty of structural reasons for a low VIX, such as falling stock correlations and more traders selling risk premium as rates remain low. On top of that, there’s evidence that the perceived calm is related to improving economic expectations. Even Federal Reserve Chair Janet Yellen, whose fellow policy makers once lamented the suppressed level of implied volatility, said in her Wednesday press conference that the "simple message is the economy is doing well.”

Still, if that’s not enough to satiate fear-analyzing desires, here are some other gauges that could be used to supplement or outright replace the VIX.

1. The Dollar

Researchers at the Bank for International Settlements say the dollar is becoming the best fear gauge as its appreciation can depress demand for credit while also reflecting reduced investor appetite for the riskiest assets. Hyun Song Shin, head of research at the BIS, in a November report, said the dollar is better than the VIX as its a truer barometer of global appetite for leverage.

2. Global Financial Stress Index

While trading below its one-year average, the Bank of America Merrill Lynch Global Financial Stress Index’s level of 0.1 is higher than its five-year mean. Positive readings indicate more market stress than normal, while negative ones signal less anxiety. The GFSI also takes more into account than just option pricing, and looks across asset classes. The gauge reached a four-year high of 0.85 in February 2016 amid a market slump.

3. CBOE SKEW Index

Despite the apparent market calm, investors have been paying up to hedge against large stock moves, a more specific measure than the VIX shows. A gauge tracking the cost of out-of-the money S&P 500 Index options has averaged 135 this year, its highest quarterly level since the final months of 2015. The CBOE SKEW Index, up 12 percent in March, rallied with the VIX when the U.K. voted to leave the European Union and before the November presidential election. The index is at its highest level since Brexit.

4. Yield Volatility

Key measures of the pace of yield changes show that fluctuations have slid this year. The Merrill Option Volatility Estimate, or MOVE Index, measures swings based on one-month options for two to 30-year Treasuries and reached its lowest since October. A similar slide is seen in the CBOE/CBOT index of 10-year Treasury note volatility. The measure gives more immediate signals through of the trading day unlike the MOVE, which only updates at the end of trading.

5. The Challengers

Some smaller competitors have also developed their own risk indexes in attempt to take a bite out of CBOE’s market share. Take NationShares, which first launched its gauge in 2013. The Nations VolDex index focuses on at-the-money options and has plunged further than the VIX to hit an all-time low on Monday. Bats Global Markets Inc. also introduced what it calls a more robust version of the VIX last year. So far, it has closely mimicked the VIX’s move down this year.

6. Credit Suisse Fear Barometer

The fear barometer, which tracks the cost of bearish to bullish three-month options, reached its highest level since the November election on Friday. It currently trades around its one- and five-year averages. The index hit a record before last year’s Brexit vote that spurred an equity selloff.

Yet even Davitt, the Credit Suisse index’s co-founder, concedes that each volatility index has its own merits, since they each take a slightly different look at trader expectations.

“You need to use them in tandem,” said Davitt. “Any one one on its own can get you into trouble.”

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