Water Flow and the Behavior of Volatility

When I was in grade school I was fascinated with math and science.  This probably explains a thing or two about my career choice.  A science ‘fact’ that I always found fascinating was that water going down a drain supposedly rotated differently in the northern and southern hemispheres.  When I first traveled to this southern half of the world I was disappointed to find that this was not true – water draining in either hemisphere is impacted by the angle of a drain or other factors and is not beholden to where the water happens to be relative to the equator.

It turns out the behavior of volatility is the same on both sides of the equator.  VIX spikes up and reverts to a mean.  We have been witness to this effect a few times recently as the drama played out in Washington, DC.  A quick comparison of the S&P/ASX 200 VIX (A-VIX) shows the same behavior out of A-VIX.  The chart below show A-VIX relative to a 10 day moving average for 2013 up to this week –

A-VIX vs 10 Day

Note A-VIX oscillates around a mean.  A spike over the 10-day moving average is often followed by a reversion to the downside.  This is not just unique to A-VIX, but shows up in equity index related volatility indexes around the world.

Starting next week, the ASX is going to roll out futures trading on A-VIX so when there is a spike in A-VIX and a trader believes a reversion to the mean is coming, trading that outlook is about to get a heck of a lot easier.

More info on A-VIX – www.asx.com.au