Buy Equity Vol - But Not For The Reason You Think

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Most equity traders are of the belief that volatility only rises in down markets. It’s easy to see why.

Looking back over the past two decades, bouts of increased volatility have predominately been associated with periods of market stress. On the other side of the coin, large stock market rallies have brought about lower volatility readings.

(Click on image to enlarge)

(Click on image to enlarge)

In fact, in 2017 while the stock market was running like it stole something, historical realized 60-day volatility stayed glued under 10% for the entire year! This was an astounding accomplishment that had a feel of “unnatural” calmness to it.

With this past market action, it’s little wonder that most traders believe that higher stocks equals lower volatility.

Yet is this always the case? Does one necessarily have to lead to the other?

Maybe we are not thinking back far enough.

If we remember back one more decade and examine the stock market during the 1990s, we notice a most curious phenomenon.

(Click on image to enlarge)

The initial stock market rise during the start of the decade was accompanied by the expected lower volatility. The 60-day realized vol bounced between 6% and 12%.

Then the Long Term Capital Management crisis hit. To no one’s surprise, volatility spiked. Nothing unexpected there.

However, after the initial panic subsided, the stock market resumed its advance, yet volatility did not return to its previous lower levels.

For the next two years, as the DotCom bubble exploded higher, volatility stayed firmly elevated.

The historical 60-day volatility gyrated in a new range between 16% and 25% - not what would have been predicted given that the bull market’s largest advance in terms of price was still ahead of it.

So this meant that purchasers of options were blessed with a more volatile underlying asset, which is one of the main determinants of an option’s value.

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Disclosure: None.

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Comments

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Terrence Howard 1 month ago Member's comment

Buying VOL is always dangerous, and best if done with VIX options not VIX-ETPs imo. No contango in VIX options

Josh Reesman 1 month ago Member's comment

What’s your vehicle of choice for this? $UVXY?

Susan Miller 1 month ago Member's comment

Welcome!

Barry Hochhauser 1 month ago Member's comment

Good Q.