Options are pricing in less volatility than normal for the S&P 500
The S&P 500 Index (SPX) has been trudging higher recently. The index is now up about 7.5% over last month’s low, and up 16% off the lows of last October. The Cboe Volatility Index (VIX), which measures implied volatilities on SPX options and usually moves in the opposite direction as the index, closed below 17 for the first time since January of 2022.
Since 1993 (as far back as we have daily data on the VIX), the VIX averages a level of around 20 with a median of about 18. Options are pricing in less volatility than normal for the SPX. In the analysis below, I look at how the SPX and VIX behaved in the past on moves below 17 and how SPY options have performed over the past several years at various VIX levels.
VIX Moves Below 17
The table below shows the dates the VIX closed below 17 for the first time in at least six months. The last time was about two years ago, and the market did well, gaining over 6% over the next six months.
To get the next signal before that you must go all the way back to 2012. Note the signal in 2008 was just before the financial collapse, in which the SPX fell 40% in the next six months. In 1998, there was a signal just before a major stock selloff after an Asian financial crisis that started a year earlier turned into a global economic crisis.
It’s not enough signals to draw conclusions, but I summarized the returns in the table below. A couple of poor outlier returns make the average returns negative after these signals.
The tables below show VIX returns after these signals, and then I summarize them as I did with the SPX above. There’s a strong upward bias, which isn’t surprising given the poor SPX returns, along with the fact the VIX is below its average level at these signals.
SPY Options & VIX Levels
In the table below I show how options on the SPDR S&P 500 ETF Trust (SPY) have performed at various VIX levels. A lower VIX means lower premiums, with the SPY requiring a smaller move for an option to be profitable.
For this data, I used actual implied volatilities on the SPY to create hypothetical call and put options that are exactly at-the-money and expire in exactly 21 trading days (about 30 calendar days). I assumed these were available every day going back to 2017. The table below summarizes the returns of the options assuming they were closed at intrinsic value on expiration.
Based on this, SPY options have been more profitable at lower VIX levels. I’m also looking at the straddle returns. For this, it assumes buying a call and put that’s exactly at-the-money and expiring in 30 days. The straddles are profitable given a significant move in the SPY in either direction.
Straddles on the SPY purchased when the VIX was below 15 have averaged a gain of 17.7%. When the VIX was between 15 and 20, like now, the straddles averaged a gain of about 7%.
Since 2017, when the VIX has been above 20, these hypothetical SPY straddles have averaged a loss of about 10%. Option traders should be welcoming lower premiums. Since 2017, given the overall bullish market, you can see calls have significantly outperformed puts.
