Someone Says Volatility Doesn’t Measure Risk

Notes from:

Volatility: A Misleading Measure of Risk

Pertinent when the VIX just hit low 10’s.

Michael Lebowitz says that there is a huge chasm between perceived risk (which if you go by VIX is 0) and reality. He like many others blames the Fed. It should be noted that hes selling “Financial Survival Guides” here. That should clue us in on what is to come in this note…

First, he includes a great quote from Chris Cole of Artemis:

“(volatility) is the difference in the world as we imagine it to be and the world that actually exists.”

The author then goes on to say that implied volatility “has been abnormally low more often than not” since 2008. “Currently implied volatility is at a level that has only been experienced 0.22% of the time since 1990 and is almost half of its longer term average.”

My issue with this is that implied volatility is the estimated volatility of the underlying price. You cannot just say “low” implied volatility. It has to be in relation to something – in this case implied (estimated) volatility has to be compared to realized (actual) volatility.

Here is their VIX chart:

Lets use the last 12 months as an example. Realized volatility is ~9%. Thats under the red line that he draws on the chart above.

This chart shows more:

My point is you can’t just say “implied vol is abnormally low” you have to compare it to realized.

Second, you could also easily make the case the markets in 1990 were totally different than they are now, for better or worse. For one, VIX options didn’t start trading until 2006. Markets are now all electronic and connected globally. Information spreads like never before. Dodd Frank, CCAR and the like have changed the risks banks can take, this is particularly an issue for hedging as they are required to have risk hedged in the event of a 20-30% equity market moved.

The reasons the author sites for this “low implied”:

  • The Fed & its easy money
  • Corporate buybacks
  • Volatility Trading
  • “Passive Mentality”

Strangely he mentions the falling dominoes the same day Martin Armstrong did. Coincidence? Someone copied someone…. I suppose his conclusion is to expect a major volatility event but he just says:

“When the entirety of the current situation begins to more fully reveal itself, investors are likely to find that the difference between esoteric measures of implied volatility and their very tangible perception of reality could not be more different.”

I think to find out how to hedge this coming cataclysm you have to sign up for their newsletter.


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