Wednesday, December 2, 2015

Volatility Explosion aka. Hotel Californication

Despite Skynet's best efforts, realized and implied (options) volatility keeps rising as the stock market falls apart sector-by-sector, stock by stock i.e. the storm beneath the Dow Jones Illusional Average...

The Black-Scholes option mispricing model uses historical volatility as a proxy for future volatility. Yes, for that they won the Nobel Prize, proving that Finance is 99% gambling and 1% Third grade math. Nevertheless, in periods when actual volatility is rising, due to 200 point Dow swings, then hedging becomes more and more expensive on the way to becoming impossible...

We've never seen this before
Historical volatility (red) aka. Standard Deviation 120 day moving average w/implied options volatility (VIX):

All because of the storm brewing beneath the calm surface...
% of S&P stocks above 200 dma:

Oil and oil volatility