Tuesday, 28 October 2008

Whither volatility?

The VIX opened on Friday 24th at 89.03. What does that mean? Using the root-t rule (which is extremely questionable at the moment, admittedly) that scales to an average daily move of 5.6%. Now admittedly things have been volatile recently. But even taking the period from 6th-24th October, the daily move in the S&P was only 4.4%. If you didn't have any other reason to trade (such as hedging a short vega position that you are panicing about), you would only buy the VIX at 89 if you thought the average daily move in the next 30 days was going to be even higher than it has been over the last two weeks extreme though they were. I'm not saying that can't happen, but it does seem unlikely to me.

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2 Comments:

Blogger Marcus said...

I enjoy reading your blog, but in this case I must disagree with you. The average absolute value of the daily change in the SPX may have been 4.4%, but the realized daily volatility (from 10/6 to 10/24) was 5.5% -- surprisingly close to implied over this period. Volatility and mean absolute deviation are not the same thing (and in fact this ratio of 1.25 is pretty normal), please see Goldstein & Taleb's paper.

7:37 pm  
Blogger David Murphy said...

Ah interesting, thank you. You are of course correct - I should have taken a minute more to compute the delivered vol...

8:54 am  

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