Expensive VIX

Despite all the VIX break out calls lately every time it ticks up, realized volatility in the SPX has not followed which makes buying options a very expensive proposition at this point. As of the close today, the VIX is quoted at a full 10 vol premium over the 1mth realized SPX volatility which is down at 14.7. As the VIX is supposed to be a forward estimate of the volatility to be realized in the next month, I took a look at historically what it meant when the premium is this large.

I extracted the sample of days when the VIX closed at > 10 vol premium over the 1mth realized volatility, the condition we are in currently. Since 1990 when the data for the new VIX methodology became available, there were 311 such days (6.3% occurrence rate).

It turns out that the subsequent realized volatility of the SPX over the next month is actually below the VIX at inception 88% of the time, by an average of 7.3 vols. The result is quite one sided and really argues against being long volatility when the premium is this large, as on average you are expected to lose 6.4% (7.3%*88%) to vega even if you do call the direction correctly. The size of the loss is 78% explained by the VIX over realized premium at inception. Furthermore, the spot VIX at the close of the period is also below the starting level in 73% of the sample, averaging 2.3 vols below. Therefore, the positive term structure of the VIX futures at the moment could be an interesting play.

On the other hand, the returns on the SPX over the next month is quite positive, averaging 1.9%, and represents a gain 64% of the time. This compares to a 0.55% return and 60% win rate over all 20 day periods during that time. The larger magnitude positive returns do tend to be skewed towards those with a higher initial starting premium, albeit not particularly well explained with a simple linear regression which only explains 33% of the correlation between the size of the return and the initial premium amount.