On the Path of SRVX CBOE’s Interest Rate Swap Volatility Index

A New Fear Gauge

 Judging by the recent behavior of the CBOE Interest Rate Swap Volatility Index (SRVX), CBOE’s new fear gauge for the interest rate market, there is little fear in that market today. The SRVX Index has lost half its value since its peak in June 2009. This fits with the seemingly permanent low level of interest rates. The CBOE Volatility Index (VIX), the barometer of equity volatility, has been almost as sanguine. The two could be suffering from Fed Doldrum Syndrome. Belying the apparent complacency, fixed income investors are likely to be worrying about an eventual end to the Federal Reserves’ low interest rate policy, and what impact that event may have on bond portfolios.  The increase of interest rate volatility signaled the 2008 debacle, and may once again warn the market about future crises. That’s why investors keep a close watch on the SRVX.

Chart 1. SRVX Indicative Value and VIX, February 2007 – May 2013

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Source : CBOE, Applied Academics, QUASaR

The mood in the interest rate market is often distinct from that in equities, and the last time their volatilities were on a similar track for such a long period of time was in 2009.  As one would expect, SRVX is more closely tuned to the level of anxiety in the interest rate market, and tends to mirror fluctuations in bond prices.

The mirror relationship between interest rate volatility and bond prices turns volatility positions into good hedges against fixed income risks, especially tail risks.  In fact, the demand for protection from catastrophic events is one of the reasons that interest rate volatility sells at a premium. For example, you can earn an annual 15% on average by shorting 3-month interest rate volatility.  Another plus is the low correlation between debt and equity volatility premiums over time. This means that selling interest rate volatility can be an effective and diversifying alternative for investors searching for yield in the volatility space.

Catherine Shalen

CBOE Research