Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

Why Individual Stock Options Got Expensive When the VIX Fell

By

Possible reasons for this unprecedented event.

PrintPRINT
As I noted last week, index volatility shot up way faster than individual stock volatility, implicitly a bet on increased correlation going forward. The correlation I refer to here is individual stocks moving in lockstep with each other.

Don Fishback quantifies what we observed somewhat anecdotally (and in chart form over on his site).

...There are several indexes that track the implied volatility of index options. The most widely known is VIX, which measures the implied volatility of the S&P 500 stock index options.

But what about an index that tells us the implied volatility of the options on the stocks that make up the individual constituent securities? For that, there is no index. Fortunately, I have a pretty extensive option database that allows us to make that calculation every evening. We call this SPXIV.

(To calculate SPXIV, we follow this process: 1. We calculate the implied volatility of the at-the-money front-month and next-month put and call options for each security in the index. 2. We use those results to create a rolling 30-day average implied volatility for each underlying. 3. Finally, we add up each underlying's average implied volatility and divide that sum by 500.)

...Two unusual things have happened the last two weeks. First, the market cracked and you got the normal rise in index option volatility as evidenced by the rise in the thin line. But what you didn't get was a corresponding rise in individual stock option volatility. While it's normal for stock option volatility to not rise as much as index option volatility in a market drop like we saw two weeks ago, the miniscule rise in SPXIV compared to VIX was even smaller than normal.


Exactly. Now one explanation could be that individual stock options were relatively overpriced ahead of the VIX storm. But that was not the case, both were overpriced early this month compared to realized volatility. But we've since receded. At least in VIXland. I'll let Don continue.

Since the speed of the decline in the market slowed down last week, VIX dropped quite a bit. Index options got relatively cheaper. That happens. Sometimes the additional decline in the market causes VIX to rise; other times VIX falls because the market's decline de-accelerates. In this case, the latter occurred.

What was unprecedented is what happened to individual stock option volatility. During this same time frame, individual stock options actually got more expensive! That is not normal! Folks, a rise SPXIV during a period in which VIX drops by that magnitude has never happened, at least in our 10+ year database.


Well, it begs for interpretation, but unfortunately that's impossible because as Don notes, this is unprecedented. My best thought is that the VIX rise during the week of January 19-22 was so relatively extreme, that the individual stocks simply caught up. If you told me the VIX popped 50% in a couple days I would have just assumed either the market had crashed or there was some huge anticipation of a game-changing event on the horizon. But stocks themselves didn't actually crash, and the anticipated "news" was not that cosmic (modest Bernanke uncertainty and the 850th alarmist warning from Stratfor in the last decade).

So my total guess is that Don's very real observation is a quirk of the unique circumstances that immediately preceded them.

No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
PrintPRINT
 
Featured Videos

WHAT'S POPULAR IN THE VILLE