Using Volatility Products to Control Risk · 2014. 2. 12. · . The S&P 500 Volatility Index:...

Using Volatility Productsto Control Risk

Dean CurnuttMacro Risk Advisors

March 9th, 2009

www.macroriskadvisors.com

www.macroriskadvisors.comwww.macroriskadvisors.com

The VIX

• One month implied volatility metric based on SPX options of many strikes

• Captures the volatility “surface”

• The VIX is driven by

•Single Stock implied volatility levels - “Micro”

•Implied Correlation – “Macro”

The S&P 500 Volatility Index: VIX

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09

Source: Bloomberg, MRA

VIX Index

SPX Realized Volatility

Rolling 3 Month SPX Realized Volatility

Apr-98 Apr-00 Apr-02 Apr-04 Apr-06 Apr-08

Source: MRA; Bloomberg Data

SPX Implied Volatility Termstructure

1 Mo 2 Mo 3 Mo 6 Mo 12 Mo 18 Mo 24 Mo

2/27/20091/6/200912/8/2008

What Causes Equity Volatility

Index Implied Volatility

“Reactive”

Realized Volatility

Single Stock RVol

•Business Risk

•Balance Sheet Risk

•Market Risk

Realized Correlation

•The Fed

•Economic Cycle

•Crude, USD

“Forward Looking”

Implied Volatility

Single Stock IVol

•Upcoming Earnings

•New Product

•Litigation / Patent

Implied Correlation

•Election

•Military Action

•Geopolitics

Macro Supply and Demand for Volatility

Source: MRA

Measures of Volatility Move Together

Source: Bloomberg Data, MRA

VIX IBOX MOVE SPX JPY/AUD B/E INF TBILL FTSE VOL SX5E VOL CALL/PUTVIX 100.0% 63.1% 27.3% -84.9% 68.3% -26.8% -44.9% 46.8% 55.1% -6.0%

IBOX 100.0% 34.6% -70.2% 54.1% -24.1% -50.3% 38.5% 46.1% -2.3%MOVE 100.0% -25.8% 33.5% -13.0% -21.9% 23.8% 29.5% -7.6%

SPX 100.0% -69.6% 20.6% 52.6% -29.2% -36.3% 5.8%JPY/AUD 100.0% -26.2% -42.2% 31.1% 45.5% -0.7%

B/E INF 100.0% 18.6% -14.7% -30.8% -4.0%TBILL 100.0% -25.5% -22.9% 9.1%

FTSE VOL 100.0% 78.1% -6.9%SX5E VOL 100.0% -7.2%CALL/PUT 100.0%

• The following correlation matrix capture the co-variation in popular measures of risk and liquidity.

• The VIX is highly correlated to measures of risk and negatively correlated to measures that capture liquidity.

VIX Risk Premium

VIX Risk Premium (3 Month Average)

Oct-03 Jul-04 Mar-05 Dec-05 Aug-06 May-07

Rolling 3 Mo Avg: VIX - One MonthSubsequently Realized SPX Volatility

Average Premium for Period

Daily Changes in the S&P 500

Absolute Value of Daily SPX % Change: Sep-Oct 2007

14%Source: MRA; Bloomberg Data

Daily Changes II

14%Absolute Value of Daily SPX % Change: Sep-Oct 2008

% Moves in the S&P

SPX Percentage of One-Day % Changes

2001 2002 2003 2004 2005 2006 2007 2008

>1% >1.5% >2%

VIX Risk Premium

VIX Risk Premium (3 Month Average)

Jun-07 Aug-07 Nov-07 Feb-08 May-08 Aug-08 Nov-08

Rolling 3 Mo Avg: VIX - One MonthSubsequently REalized Volatility

Average Premium for Period

Selling Volatility…Once Profitable

Aggregate P/L of Selling One Month SPX Variance

Jan-07 May-07 Sep-07 Jan-08 Jun-08 Oct-08

Aggregate P/L ($mln) of selling 10kvega of one month SPX varianceeach day struck at the closing VIXlevel

Index Option Volume and the VIX Moves Together

Option Trading Goes Macro

Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-090

SPX Option % Total Option Volume

VIX Index (right scale)

SPX Volume = SPX Options + SPY Options; 10-Day Moving Averages

JPY / AUD

Carry Trade Unwind

Jan-08 Feb-08 Mar-08 May-08 Jun-08 Jul-08 Sep-08 Oct-08 Dec-08 Jan-09

JPY / AUD

11/20/08

CDX IG 5 Year

Jan-08 Feb-08 Apr-08 May-08 Jun-08 Aug-08 Sep-08 Dec-08 Jan-09

IBOXUMAE Index

11/20/08

1 Month LIBOR / OIS Spread (bps)

1 Month LIBOR vs. OIS

Jan-08 Feb-08 Mar-08 May-08 Jun-08 Aug-08 Sep-08 Oct-08 Dec-08 Jan-09

1 Month LIBOR

USD SWAP OIS 1 Month

10/10/08: Spread = 338bps, VIX = 70

CMBS Spread

Super Senior CMBS Spreads

Nov-04 May-05 Nov-05 May-06 Nov-06 May-07 Nov-07 May-08 Nov-08

Morgan Stanley US Fixed RateCMBS Super Senior AAA AvgLife 10 Year Spread

11/21/08

The VIX & Credit Default Swap Spreads

Scatter Plot: VIX vs. Generic 5 year IG

0 50 100 150 200 250 300

Actual Observation (since 2007)

Trend Line

2/27/09

11/20/08

VIX & S&P Earnings

S&P 500 Quarterly EPS vs. VIX

Mar-90 Mar-93 Mar-96 Mar-99 Mar-02 Mar-05 Mar-080

S&P500 QoQ% Earnings Per Share

The Consumer and the Economy

Consumption

Profits

Equity Prices

Income

Equity Vol

Wealth

Sentiment

Housing Stocks

“Micro”

“Macro”

Source: MRA, Bloomberg Data

Consumer Obligation Ratio

Consumer Financial Obligation Ratio

80q1 83q1 86q1 89q1 92q1 95q1 98q1 01q1 04q1 07q1

The household debt service ratio (DSR) is an estimate of the ratio of debt payments to disposable personal income. Debt payments consist of the estimated required payments on outstanding mortgage and consumer debt. The financial

obligations ratio (FOR) adds automobile lease payments, rental payments on tenant-occupied property, homeowners' insurance, and property tax payments to

the debt service ratio. Source: MRA, Federal Reserve

Household Balance Sheets Under Stress

Change in US Households Net Worth (Trillions)

Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08

Federal Reserve US Households & NonprofitOrganizations Net Worth Change

Tighter Lending Standards…

Fed Senior Loan Officer Survey

1990:3 1993:3 1996:3 1999:3 2002:3 2005:3 2008:3

Mortgages

Credit Cards

% of Respondents Reporting Tighter

Lending Standards

Source: MRA, Federal Reserve

The Real Estate Downturn

Case Shiller Composite Index year over Year % Change

Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

2009 Low Print in VIX

What Will the Low Print inthe VIX be in 2009?

Source: MRA Survey

Each circle represents an individual survey response

A New Meaning of Low for the VIX…

2009 High Print in VIX

What Will the High Print inthe VIX be in 2009?

Source: MRA Survey

Each circle represents an individual survey response

And a Wide Range for 2009…

SPX Realized Volatility Forecasts

2 Month 6 Month 12 Month

MaximumMinimumMean

Source: MRA Survey

Termstructure of Forecasts

Conclusions

• Equity volatility likely reached its highest point in Oct / Nov when the VIX closed above 80

• The government has thrown the “kitchen sink” at the market with various liquidity backstops

• However, we expect volatility to persist at well above historically normal levels for some time

• 3 Factors continue to drive equity volatility

•Government intervention (picking winners and losers)

•Deleveraging (fear of and actual impact of)

•Unfolding economic contraction and resulting difficult corporate profit environment

• Risk has become highly macro (credit, FX, equity, commodity, rates) and equity volatility products have been instrumental in helping control overall portfolio risk.

Using Volatility Products to Control Risk · 2014. 2. 12. · . The S&P 500 Volatility Index:...

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