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Why Did the VIX Drop After Tariffs Were Hiked?

May 10, 2019

 

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The VIX is below 17 today after reaching a high of 23.38 yesterday.

Now, why did it drop AFTER the news that the US will hike tariffs on $200 billion in goods from China?  

Let’s take a look at the mechanics of the VIX to better understand.

  • The VIX is merely an estimate of implied volatility derived from 30-day S&P 500 index options.  It almost like buying a swap (a variance swap) on implied volatility 30 days from now!
  • Typically, the VIX gets bid up ahead of major “risk” events as investors buy puts to protect their portfolios.
  • In some ways, you can think of the VIX as a form of implied risk premium.
  • AFTER an event occurs, typically, investors don’t buy puts because it is illogical to buy hedges to protect your portfolio from an event that has ALREADY occurred.
  • What usually happens is that the VIX begins to trend down from its highs post an event  demand for additional puts is waning!

 

VIX - Volatility Index, 5 Years

vix index 5 years

Source: Bloomberg

So what happened Today?  Well, ahead of the tariffs decision, investors were buying puts.  After the decision was made, there was no need to buy additional puts.  Sometimes, you can even observe the S&P 500 selling off while the VIX ALSO trends down.  This phenomenon happens simply because the options markets anticipate what will happen while the stock market is often reactive. 
 

  • The VIX has moved above the 20 level 18 times over the last 5 years as the graphs above show
  • Most moves above 20 are short-lived, the end of 2018 saw one of the longest periods over the last 5 years

 

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