VIX May Form the ‘Mother of All Inverted Vs’By
SocGen expects term structure to normalize in coming weeks
MKM sees ‘floor’ elevated above 10-11 level of recent years
The Cboe Volatility Index may not go back to its extreme lows of the past few years, but strategists at Societe Generale and MKM Partners LLC think it’s headed in that direction.
“We expect the term structure to gradually normalize over the next few weeks,” strategists Jitesh Kumar and Vincent Cassot of SocGen wrote in a note Wednesday.
Exchange-traded products based around the VIX ran into trouble when the gauge spiked on Monday and Tuesday morning, setting off an $8 billion time bomb with consequences for investors big and small who had sought to bet that low volatility could continue. The gauge reached as high as 50, compared with a 12-month average of just 11.3.
MKM said the VIX term structure -- the difference between volatility options with different maturities -- was “extremely steep” during the market meltdown earlier this week, in comparison with the six to seven points seen during historical events.
“Aside from August 2015, there is no other volatility event over the last 40 years that would look remotely like the current one in terms of its profile if VIX continues to melt down from here,” MKM derivatives strategist Jim Strugger wrote in a note Wednesday. “Of course if this event turns out to be the mother of all inverted V’s, then we believe the muted reaction in longer-dated futures will have had it right.”
MKM remains constructive on U.S. stocks given solid growth fundamentals in the U.S. and globally, seeing further equity gains punctuated by volatility events with higher magnitude than the markets have seen in the past few years. Higher volatility has been able to coexist with upward-trending stocks, Strugger said.
“The aftermath of the volatility transition we foresee would embed a floor under VIX higher than the 10-11 level of the last several years,” MKM said, adding that in the late 1990s and ’00s regimes the floor was around 15. “We’ll know in the coming weeks if this inflection is real.”