May 16, 2017 | Post by: Roman Chuyan, CFA Comments Off on What Volatility Drain Means To The Market

What Volatility Drain Means To The Market

After a rebound in the second half of April, U.S. equities (+8% year to date) stabilized, while global markets excluding the U.S. continued to push higher, driven by a relief rally in European markets after the French election on May 7th. When the stock market rises, its volatility tends to drop – which is what happened in recent months. Implied volatility priced by S&P 500 options (the VIX index) dropped to around 10% (see chart), the lowest in ten years.

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Implied volatility can be viewed as a measure of investor sentiment, and some commentators have taken this volatility drain as a bearish sign. I’d like to point out two things in this regard. First, the VIX follows actual (“realized”) volatility of the S&P 500, which has dropped significantly over the course of this rally: 3-month trailing volatility is now around 7%, compared with 21% over the past ten years.[1] Second, the last time the VIX dropped to 10% was in Nov-2006, and it remained low until Feb-2007 while the index continued to rise. The volatility drain does point to significant optimism, and we know that it will reverse sooner or later. However, a more important question is when – it may reverse in the short term but may not point to immediate danger.

Finally, it is important to account for investor sentiment, and our equity model includes measures – the AAII Bears/Bulls and the Put/Call Ratio – that historically tend to be better market predictors than the VIX. The Put/Call Ratio, at 0.75, indicates very bullish stance by traders, and our statistical model calculates a negative effect of this factor on expected 6-month return for the S&P 500 of -0.9%.

[1] Measured as standard deviation of daily S&P 500 returns, and annualized.


Disclosures: Roman Chuyan is the president and general partner of Model Capital Management LLC, a Registered Investment Adviser. This article is for informational purposes only. There are risks involved in investing, including loss of principal. Roman Chuyan makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by him or Model Capital Management LLC. There is no guarantee that the goals of the strategies discussed in this article will be met. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any security. Asset allocation, tactical asset allocation, TAA, tactical investing, tactical management, ETF, tactical investment management, Financial planning systems for advisors, Financial planning tools for advisors, Financial planning tool for advisors. Envestnet, TD Ameritrade, Adhesion, Best TAMP, SEI Advisor Network, Schwab intelligent portfolios. Betterment institutional, Schwab PortfolioServices, Dynamic wealth advisors. Investor onboarding, Financial planning platforms, Client onboarding for wealth firms, investment management for WM. Investment management for advisors, Schwab performance technologies, SEI Advisor, Ameritrade Adhesion, Best TAMPs. Investment management platform, SEI Asset Management, Schwab Portfolio Services, Investment management platforms. Schwab Portfolio Center, AssetMark, Financial planning system for advisors, Orion Advisor, SEI Practice Management, client onboarding for WM. Financial planning software for advisors, Robo plus, Financial planning platform. Turnkey asset management platform, client onboarding wealth management, SEI Advisor Center, Orion Advisor Solutions, Schwab PortfolioCenter. Robo advisors plus, SchwabPT, Adhesion Wealth, investment management for advisor. Client onboarding for wealth, Turnkey asset management platforms, investment management for advisory, Schwab intelligent portfolio.

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