The Vix index has this week closed at its lowest levels since the crisis began five years ago. That means investors feel less need to hedge in the options markets against future (implied) volatility than at any time since the crisis started.
Is this flashing a red warning light that the equity market is overly complacent, and about to crash? Other measures of dollar-linked short-term implied volatility – on bonds, gold and dollar exchange rates – are also very low.
If the Fed is about to put a floor under prices, handing out free “Bernanke puts” via QE3, why pay for put options yourself to protect your portfolio? Perhaps the over-optimism is really focused on the prospects for Federal Reserve action, not merely bets that the summer rally will continue. US economic conditions have been improving a little, and that ought to reduce the chance of QE3.
This idea is backed up by longer-term versions of the Vix, long-dated volatility. This is trading at a significant premium to short-term volatility, suggesting worries remain, particularly around the end of the year. Indeed, the gap between 3-month (November) and 12-month volatility on the euro/dollar exchange rate is the highest on record.
Charts below show the short and long-dated volatility on the S&P 500, and the ratio of bearish put options to bullish call options on the S&P 500 index, which is also extremely low (as a consequence of the collapse in puts). Read more