(Bloomberg) -- The great volatility spike of 2024 was triggered by a sudden wave of deleveraging on Wall Street — rather than a collapse of economic confidence with echoes of the pandemic-era dark days. Now all market signs suggest that calm is set to return to U.S. stocks after the recent mayhem.
That, in a nutshell, is the benign message from the owner of the Cboe Volatility Index, which registered its largest intraday jump last Monday, in a move dubbed suspect by the former Treasury Secretary Lawrence Summers.
Cboe Global Markets Inc. acknowledged that thin trading premarket played a role in VIX’s violent move but said its surge was justified by the mounting angst over the contagion risk emanating from a crash in Japanese currency and stocks, which led to the yen carry trade unwinding. At that moment, S&P 500 futures dropped 4.5 per cent, equaling to an annualized volatility of 70, according to Mandy Xu, the firm’s head of derivatives market intelligence. The VIX surpassed 65 at this peak.
“Given the large SPX futures move premarket, a corresponding large move in the VIX index really isn’t that surprising,” she said in an interview.
Yet derivatives specialists argue that the surge may have exaggerated bearish sentiment due to a lack of liquidity, short covering in misfired volatility bets, and the fact that some illiquid options contracts go into the index’s calculation. They pointed to an unusual price gap between the VIX and its futures contracts as evidence that the fear gauge was untethered from the market reality.
The VIX’s 42-point climb over less than five hours on Aug. 5 took it to 65.73 at 8:37 a.m in New York. But August futures tied to the index rose by only about 5 points over the same timespan. At its widest point, the gap between the index level and that of its front-month contract was 32 points.
That spread didn’t last long, and by the end of the session it had shrunk to 8 points. To some market watchers, the swift comeback is an indication that the initial VIX jump likely overstated the fear among investors.
The argument reflects the fact that the VIX itself isn’t actually traded, it’s a mathematical quantity derived from the price of options on the S&P 500. By contrast, its futures contracts reflect actual money flows.
When the pandemic hit, the two surged in lockstep. This time, the dislocation underlined a different backdrop, according to Cboe’s Xu.
During Covid, it “was both a liquidity event and a macro shock,” she wrote in a note to clients. “What happened on Monday was purely a liquidity event,” she added. “There was no fundamental/macro reason underlying the move and therefore no reason to expect volatility to remain persistently high once the deleveraging was over.”
In a Bloomberg Television interview with David Westin on Friday, Summers said the VIX had “a somewhat artificial move” due to the inclusion of some relatively illiquid instruments in its calculations. While this remark raised questions on the measure’s methodology, it can be argued that the VIX worked just as designed.
Cboe declined to comment on Summers’ allegation.
Rocky Fishman, founder of derivatives analytical firm Asym 500, said one volatility strategy in particular may have fueled the VIX’s ascent. Known as the dispersion trade, investors typically bet on smaller swings in an index while wagering on higher volatility in its member stocks.
On Aug. 5 though, the VIX’s premarket surge was accompanied by a rise in the cost of S&P 500 options above that of Apple Inc. and Microsoft Corp. — a departure from a typical pattern where the two components cost more. That suggests dispersion traders contributed to the volatility spike, he said.
Cboe’s Xu disagrees, citing a mild increase in expected correlation among S&P 500 stocks. By her model, one-year implied correlation added only 4 percentage points last Monday to 28 per cent. That’s well below the average reading of 38 per cent in the past five years.
“Last week was not driven by an unwind of the dispersion trade,” she wrote.
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