2015 is behind us and the S&P 500 dropped (more than a rounding error) for the first time since 2008. If you want to put a positive spin on the year you can say with dividends the S&P 500 was higher. It was a fun year to be a market participant as we experienced some things that could be considered new or at least different relative to recent market history. Since everyone loves lists, or gets easily sucked into them, here are five takeaways from the volatility markets in 2015.
1. VIX Average Closer to Historical Norms
Last year VIX averaged 16.67 which was over 2 points higher than the average for both 2013 and 2014. As I write this I note there was very little of the “is VIX broken” stuff coming out of the media in the second half of 2015. The chart below shows the range and average by year going back to 1990. The technical analysts will note 2015 had a higher high, higher low, and higher average (trend change?).
One other chart with respect to the VIX average shows up below which shows the rolling 1, 5, and 10 average closing prices for VIX since 2000. Note the 10 year average remains pretty steady around 20 which is the number that is often cited as a long term average for VIX (because it is the long term average for VIX). To maintain that long term average VIX is going to need to be elevated over the next few years.
2. Russell 2000 Volatility Was Relatively Low
Russell 2000 implied volatility as indicated by the CBOE Russell 2000 Volatility Index (RVX) was relatively low in 2015. The average for the year was 19.39 which was actually down a bit from 2014’s average of 19.42. Also, many of us volatility watchers like to compare RVX to VIX. The chart below takes the closing level of RVX and divides it by VIX. Until 2015 there had only been one trading day where RVX closed lower than VIX. This past year is happened several times as indicated by the ratio closing below 1.00.
3. SKEW High for the Second Year
In 2014 the average for the CBOE SKEW Index was 129.75. I personally brushed that record aside thinking it was a function of VIX being at relatively low levels (I was wrong). Last year SKEW averaged 127.50, despite VIX averaging a higher level than in 2014. I’m hearing rumblings that there is a structural market change with respect to institutions using out of the money SPX put options to hedge against any dramatic drop in the stock market. The thinking is due to regulatory restraints many institutions are judged on their ability to weather any sort of dramatic financial market weakness (think the stress test). Holding out of the money SPX puts is an efficient and relatively cheap way to pass a stress test which increases the demand for those puts and results in elevated out of the money implied volatility when compared to historical levels.
4. VIX Backwardation Lives!
The table below is my own method of determining whether the shorter part of the VIX curve is in contango or backwardation. For VXX traders the column showing where Month 1 closed higher than Month 2 is most significant. About 1 in 5 days last year the front month was at a premium relative to the second month which benefits the performance of VXX. Despite this VXX was down about 36% last year.
5. Long and Short Volatility ETP Performance
As noted in the previous point VXX was down 36% last year, despite a little more backwardation that we have seen in years. There are also some ETPs that offer the inverse return of VXX, but on a daily basis so compounding may result in one of the inverse funds not having the inverse performance of the long fund over time. In a choppy year, like 2015, there can be a dramatic disconnect and there was. There are a couple of short funds, but I focus on SVXY as it has an active option market. SVXY was not up 36% in 2015 as VXX was down 36%. In fact SVXY lost value as well dropping 17.5% for 2015. If anything this is a great lesson in how inverse funds do not return the opposite of their long fund counterparts and the more volatility the underlying market the bigger the possible disconnect.