Is 2020 Going to be More Profitable for VIX Shorts – Recovery Hope Fuel Bets on Lower Volatility?

The WSJ  Friday July 3, B11 article “Recovery Hope Fuel Bets on Lower Volatility” says that traders are projecting calmer markets as the VIX drops to a low 28. We analyzed variance swaps for the last 14 years and our take on payouts is presented here.

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Persistence in Volatility

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The VIX has been very high last few months and at 35 today. Some talking heads on CNBC have been suggesting that this is the time to buy momentum given elevated volatility. I tested the data and find no relationship between past volatility and near-term future returns. I do find volatility clustering effects, which is very high, but this in itself is non-sequitur to a suggestion for entering into equity momentum trades.

Historical volatility measures can forecast future volatility, albeit with some error. Volatility clusters when periods of high volatility followed by periods of high volatility, and periods of low volatility tend to be followed by periods of low volatility. We also tested with VIX, a  forward- looking measure, to find materially similar outcome. Constant volatility exposure can be arrived by de-leveraging when past volatility was high and leveraging when past volatility was low. No relationship between past volatility and near-term future returns.

Volatility is Correlated to Lower Credit Rating and Negatively to Equity

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ActiveAllocator Research – Response to WSJ , June 13, 2020 “Investors Bet on Volatility Making Markets Even Wilder”. I read and decided to test for the relationship between volatility and equity markets and credit ratings. Prelim results suggest that VIX is negatively correlated to equity indices, positively correlated to credit, predicts and serves as a leading indicator and reacts quickly when uncertainty increases.

Investors Bet on Volatility in 2020

“Investors Bet on Volatility Making Markets Even Wilder”  WSJ , June 13, 2020

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With investors increasingly focused on volatility trades the VIX is now an increasingly popular trading instrument. Trading profitability depends upon market returns, where the VIX futures are trading relative to VIX spot, and the absolute level of the VIX at trade initiation. VIX is negatively correlated to equity indices.