The traditional method for measuring volatility has been the Vix Index, dubbed the ‘fear index’ by the media. But this is something of a misnomer.
Technically, the Vix is the CBOE Volatility Index, which shows the market’s expectation of 30-day volatility of the S&P 500, quoted as a percentage range of movement over the next year at a 68% confidence level.
It is a good measure to quote but, given its intangibility, it is a difficult asset to invest in.
This is in part because volatility is a decaying asset and any investable index needs to reflect the ability to roll its futures contracts.
Rolling involves selling the current contract and buying a longer-dated future, but the price of these is almost always higher than a shorter-dated contract, which leads inevitably to losses when the contract is rolled.
But it is also down to how markets respond to volatility. While the media often highlights uncertainty, the equity markets move slowly higher.
For the past five years, equity markets have experienced very little volatility.
From looking at the Vix since 2000, it is clear investors going long volatility have suffered material losses.
This is the crux of the issue: the Vix is not a general fear index but an equity-related product and therefore a corporate fear index.
And right now, with strong balance sheets, low interest rates and easy access to liquidity, there is no fear in the corporate world like there was in 2001 and 2008.
This is backed up by other measures of corporate risk such as the CDX indices, which express how credit markets respond to volatility.
This is not to say the Vix and its counterparts are not good investments at today’s historic lows; the ability to make exponential upside certainly exists if the current calm in the corporate world evaporates.
