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Why a complacent VIX makes me nervous

The call:put spread measure of the volatility index (VIX), sometimes referred to as the level of put protection, is back at pre-CNY devaluations levels.

Charts
Source: Bloomberg
  • The US VIX has declined from 30 to a low of 13.4 in two weeks. It has declined eight out of the last ten days and is trading a full standard deviation off the historical average, even as most point to the S&P and DOW being overbought and overvalued again.
  • The ASX equivalent XVI hit 13.7 yesterday, the lowest level since 20 July 2015. It has declined 55% since the 10 February capitulation. It’s also trading over a standard deviation from the historical average of approximately 19.5, yet the ASX has seen trade volumes fall to 27% below the 30-day moving average as buyer exhaustion hits
  • Intraday volumes through the US, European and Australian options markets have also declined by as much as 30% in the past 30 days. Put protection buying has plummeted to complacent levels.
  • Deutsche Bank’s ‘complacency index’ is at its highest level since the top of the market last year.

Complacency breeds laziness and roots out diligence, which is not great when macro risks are everywhere.

The Economist Intelligence Unit has ranked 10 macro risks that may cause what could be massive shocks to global equity markets.

Four out of the ten global risks stand out as near term risks:

  • Number one on the list is a China hard landing, which has been a risk factor for over 10 years. It still remains the biggest global risk and it would severely affect Australia if the GDP targets were to fail.
  • Number six on the list is Mr Donald J Trump becoming President of the United States. We are 117 days from the start of the Republican convention in Cleveland, and Mr Trump is on course for the nomination. Besides the social unrest he may create, the protectionism and trade risk that may arise would see gold having its best year since 2011.
  •  The horrendous event in Brussels illustrates that the seventh item of terrorism will be an ongoing risk.
  • And the eight risk is the Brexit, with 71 days until the 2 June referendum. GBP was shelled overnight due to the Brussels attack. It is believed that this strengthened the exit campaign and according to several betting agencies, the odds of Brexit have now increased to 46%. As we get closer to the date, the Brexit will shift up the risk order and the VIX will go with it. The economic impacts have been exaggerated by both sides but it will have a major impact and it will fracture Europe further.    

The VIX cannot continue this level of complacency for much longer. Increases in put protection will signal that buyer exhaustion is upon us and the fixed risk dates are beginning to impact short-term trade.  

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