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Deflated S&P 500-Based VIX Pulling Other Volatility Measures Down

Deflated S&P 500-Based VIX Pulling Other Volatility Measures Down

Talking Points:

  • The VIX has already found itself deflated to what are arguably natural lows around the 10-11 handle region
  • Where equity based volatility measures are already deflated, there is still premium to work off in other assets
  • Despite heavy price activity, crucial event risk ahead and a build up of exposure; volatility reads are dropping fast

See how retail traders are positioning in the FX majors, gold, oil and global equity indexes using the DailyFX SSI readings on the sentiment page.

Volatility as measured by favored benchmarks like the VIX Index seems all but nonexistent. However, there is still plenty of activity to be found across the financial system. In a practical sense, actual price action suggests far greater turbulence ahead than what is currently being accounted for through the implied volatility derived from options pricing. This difference between realized and expected volatility is a tangible measure of the reach in complacency across the markets. While the extended period of calm and productive climb for speculative assets doesn't speak to impending doom, it certainly doesn't equate a significant deleveraging of exposure is the equivalent of a black swan event. Yet, with the VIX already-extreme at lows; the ability to draw extreme signals is diminished and the more speculative elements in the market take greater responsibility for maintaining stability.

While it would seem we have already sucked the air out of the speculative market, there is still room for the broader market to position itself broadside to rogue waves. Other asset classes have plenty of premium to spread the complacency - and that is what we have been seeing in volatility measures for other markets as of late. Where the VIX has bottomed out late last year, there was still plenty of risk premium accounted for in the FX markets, gold, crude, Treasuries and emerging markets. In the past three months, however, that anticipation has drained away. In the past week, the deflation has accelerated markedly with some measures hitting multi-year lows. The activity measure from gold for example dropped sharply to an August 2014 low this past session despite a typical negative correlation to the underlying metal and an extended slide for spot.

The pull on defense anticipation is strong when exposure is the greatest. An implicit cost for hedges eats into marginal returns - especially in a low rate environment. That can also set the stage for instability. When market participants find themselves or the market as a whole far out on a branch it creates a sense of hyper-vigilance and reaction. That is a risky situation to be in when there are still heavy fundamental fronts anticipated ahead: from monetary policy fall out, political change, strained global trade relations and more. Seeing the tide move out so quickly and comprehensively should encourage caution in traders - if they are not already on alert. We discuss the remarkable changes in financial-wide volatility measures in today's Strategy Video.

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.