Friday, November 20, 2015

Volatility Feedback Loop

Options Implied Volatility (VIX/VXO/VXV etc.) is imputed from options prices. It measures gambler "demand" for downside insurance protection. Options that are not actively traded are (mis)-priced by Skynet based upon historical volatility, which is usually mean reverting, except now...apparently 300 point daily Dow swings are not that common after all...


In other words actual volatility feeds back into options implied volatility, making the highly popular volatility short trade highly unprofitable...

The short volatility ETF:



(Implied) Volatility is rising, because (Actual) volatility is rising, making it more expensive to hedge.  

And we ain't seen nothin' yet...