Oct 29, 2015

Volatility In Focus: Should We Fear the VIX?

In this video blog Jim Jockle, CMO of Numerix speaks with Kevin McPartland, Head of Market Structure and Technology at Greenwich Associates about trends in volatility.

He examines how the evolution of volatility as an asset class and the rise in popularity of volatility trading is impacting equity derivatives, target vol strategies and structured products.

Specifically, Jim points out an interesting aspect of the article where sellers of short term VIX are effectively short Gamma and need to scramble and buy Vol as it rises. This is causing a fascinating phenomena where by trading volatility, you are actually creating more volatility.

- See more at: http://www.numerix.com/watch-list-october-8-volatility-trading-vix-vvix#sthash.iH2xthUM.dpuf

Jim and Kevin discuss the rise in popularity of volatility, specifically how more volatility is actually being created as an increased number of market participants trade the VIX. They also note that as volatility rises market participants like trading firms, exchanges and liquidity centers typically see better performance.

However, from an investor perspective - short terms vs. long term impact can vary. As the role and impact of volatility is in the eyes of the beholder, we ask if the "fear index" really something to fear anymore? Despite these perspectives, Kevin concludes by saying that the Fed and monetary policy will still have the biggest impact on volatility going forward.

mines how the evolution of volatility as an asset class and the rise in popularity of volatility trading is impacting equity derivatives, target vol strategies and structured products.

Specifically, Jim points out an interesting aspect of the article where sellers of short term VIX are effectively short Gamma and need to scramble and buy Vol as it rises. This is causing a fascinating phenomena where by trading volatility, you are actually creating more volatility.

- See more at: http://www.numerix.com/watch-list-october-8-volatility-trading-vix-vvix#sthash.iH2xthUM.dpuf

Weigh in and continue the conversation on Twitter @nxanalytics, LinkedIn, or in the comments section.

Jim Jockle (Host): Hi welcome to Numerix Video Blog, your expert source on derivatives trends and topics. I’m your host Jim Jockle. Joining me today is Kevin McPartland Head of Market Strategy and Technology for Greenwich Associates, to discuss some of the recent trends going on around the VIX. Welcome Kevin and thanks for joining.

Kevin McPartland (Guest): Thanks for having me Jim.

Jockle: So, let’s start with a question: volatility now in these markets is actually creating more volatility and I think one of the more fascinating trends that we’re seeing is the explosion in option pricing. So in terms of trading on the VIX and going forward, do you see this as the next foreseeable future in the market?

McPartland: Volatility has been so low so for so long right, just like interest rates it seems like it only has one direction to go, but it doesn’t seem to go that way. So we’ve been looking at this for quite some time and it’s interesting to look at how it’s different across different asset classes. So in FX for instance, volatility ramped up about a year ago and it seems to be sort of staying there. There’s quite a bit of volatility in those markets. Treasury markets it seems to come and go in the race market, so we obviously saw a big jump in volatility there, really across everything in August. But again, it seems to have calmed down a little bit again and volatility in equities is the most volatile of volatilities; that it very much comes and goes in big swings. It felt like equity volatility was back and was going to hang around in August and early September and now here we are working our way into the fall and it sort of back down into the teens again.

Jockle: So, I think one of the fascinating trends was if you looked at the VIX purely in 2008, you had levels trading up around 60. Then we settled back for a nice, quiet period for a little bit, you know in the 13, 14 range, but now the spikes are getting shorter but they’re also staying in a range. We’re going from 13, we’re going to 30, we’re back down, it’s kind of a 2 or 3 week period, but also the options on those are exploding. So the volumes in 2008 has almost tripled in terms of where we are today in these peaks. Tell me, obviously money is being made, but where are the winners and losers in this explosions of an option?

McPartland: I mean there’s certainly some sort of day-to-day winners and losers that are essentially betting on the volatility of volatility. But I think the bigger picture here is about the bigger market participants. So you have the big banks, the principal trading firms, exchanges, liquidity centers, you know such as the bond ECNs. They make money on volume and volume tends to come along with volatility. So the more volatility goes up, the better all of those participants ultimately will do. From an investor perspective, it gets a little more nuanced. So for real money, you don’t like volatility, you’re in it for the long term; you’re holding a position, you’d rather the markets just be calm and slow and steady and grow over time. For those that are a bit more focused on maybe arbitrage strategies or just more quantitative in general, then moving markets create opportunities for them to make returns for their investors. So you know by and large volatility is a good thing for most in the institutional financial markets. If anything I think it’s just sort of the longer term investors that would prefer things to just stay calm forever.        

Jockle: So is it time to remove the moniker “the fear gauge”?

McPartland: That’s a great question. I mean should we really be afraid of it. I mean it does certainly give some inkling of how much the markets expect things to change in the near term. You know whether they’re afraid the change maybe was the question you’re getting to. I think the other bit is how correlated will volatility stay to what the expectations of the Fed. And we can’t say volatility how will it stay in association to rates, because there aren’t any rates, but it really it is sort of what’s coming out of the Fed and volatility seems to react more to what happens at the Fed than it does to anything else. Maybe save China, but maybe that’s for another podcast.

Jockle:  So that brings up a really interesting question, regulators like smooth, predictable ongoing markets, but the introduction of volatility especially when you’re getting these peaks and trails within trading, that not only has the potential impact on earnings from financial institutions on a quarter-by-quarter basis, but also introduce more volatility; could have dramatic effects on your 401k, especially if you’re nearing retirement. So where do you think the regulators are going to stand-in as we start to see more volatility type trading?

McPartland: Well the question is what can you do to regulate volatility right away. I mean, these markets are driven by human emotion first and foremost, despite the technology and everything else that underpins them. If people are expecting a certain kind of change they’re going to react to that no matter what the regulators tell them they can do. If anything, it takes us back to a sort of broader retirement planning ideas, where if you are getting close to that point where do you put your money? Where do you avoid the volatility, do you move more to cash? It’s not an easy question to answer today because lots of folks feel that fixed income markets and equity markets are overvalued at this point and you will see volatility and could certainly trend downward over the sort of the short-term. It’s a tough spot if you’re nearing retirement; if you’ve still got some years to go you know, it’s old-fashioned advice: just keep buying, buying, buying and hold steady and over the long run you’ll still come out ahead.   

Jockle: So you also mentioned FX a little bit and obviously the China devaluation was a clear tipping point; injecting a lot of interest into the market place. Things have settled down a bit more, the interest rate question on the US side is still out there. Are there any other particular inflection points on the near-term horizon that you would be concerned about for FX?

McPartland: I mean I think we can’t ignore, China’s a big deal, it’s a huge economy, and I think the US economy will more and more be impacted by other large economies around the world. I think there are also some perpendicular issues like oil prices for instance and volatility in that region that could have some impact on currency markets. But you know in the end, I think we still come back to monetary policy as the biggest driver that’s going to impact or where the FX markets goes. What the Fed does that impacts the US Dollar that the impacts all other currencies that have some connection into the dollar for the time being that is still going to be the biggest impact on currencies.

Jockle: And Donald Trump as President? Is that a volatility event?

McPartland: It certainly creates good television, but we’ll see how that pans out as we get closer to the election.

Jockle: Well Kevin, I want to thank you so much for joining us today and sharing some insights. And with that of course we want to talk about all the topics that you would want talk about so please follow us on Twitter @nxanalytics or on LinkedIn, you can just look at the Numerix page. Thank you so much for joining.

Weigh in and continue the conversation on Twitter @nxanalytics, LinkedIn, or in the comments section. - See more at: http://www.numerix.com/watch-list-october-8-volatility-trading-vix-vvix#sthash.iH2xthUM.dpuf
Weigh in and continue the conversation on Twitter @nxanalytics, LinkedIn, or in the comments section. - See more at: http://www.numerix.com/watch-list-october-8-volatility-trading-vix-vvix#sthash.iH2xthUM.dpuf
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