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Here's a good VIX article.

In Simple Terms

Historical, or actual, levels of volatility have fallen to very low levels through the first quarter of 2012. Not only are some of the important sectors seeing quiet action, but also the 30-day historical volatility of the S&P 500 is down to low levels of only 10.5%. Another way to conceptualize the market’s range-bound action is to consider that the average daily move in the S&P 500 so far this year has been only 5.9 points, or about .45%. The action stands in stark contrast to the situation in the fall of 2011 when 2.5% moves in the S&P 500 were not entirely unusual.


SECTOR YTD GAIN 30-DAY ACTUAL VOLATILITY
Consumer Discretionary 12.40% 10.70%
Consumer Staples 3.40% 6.20%
Energy 6.70% 12.90%
Financials 14.20% 16.40%
Health Care 5.10% 9.10%
Industrials 9.60% 14.10%
Information Technology 14.80% 10.50%
Materials 8.80% 17.30%
Utilities -1.10% 5.50%
S&P 500 9.00% 10.10%

FIGURE 2: S&P SECTORS YTD PERFORMANCE AND 30-DAY VOLATILITY (THROUGH 3/12/12). There’s been a modest uptick in volatility in the financials, basic materials, and energy groups since the February 2012 Vol Report. Still, a “quiet grind higher” is the best description for the market action across most sectors so far for 2012. For illustrative purposes only. Past performance does not guarantee future results. Data: Thomson Reuters


Quiet and orderly trading has helped create a very steep curve in the CBOE Volatility Index (VIX) term structure—which is just a fancy term to mean a curve that displays the current volatility reading of the VIX. The Chicago Board Options Exchange [CBOE] disseminates real-time readings for the index throughout the day. The VIX’s value is based on the amount of volatility currently reflected or “implied” by S&P 500 Index options.

The exchange also computes various future and forward values for the VIX, which are also based on S&P 500 Index options. However, instead of assessing a value based on front-month options as the spot VIX does, the term structure values for future months are based on the implied volatilities of those back-month options. The concept is similar to the term structure of interest rates in the bond markets. The term structure of VIX options gives us a clue as to what the players in the options pits expect about volatility in the months ahead.

For example, as of this writing, VIX is at 15.47, its lowest levels since May 2011. But, the term structure for forward value of VIX options (Figure 3) shows April in the high teens. By mid-September 2011, it approaches 24. So presently, the term structure is steepest at the back months. December is almost 30.





FIGURE 3: FORWARD VIX values indicate we’re not out of the woods just yet. Current VIX values as of March 12, 2012 indicate low volatility into the future. Not so, say back-month values. For illustrative purposes only. Past performance does not guarantee future results. Source: CBOE.


If VIX is at 15.47, September forward values are near 24, and December almost 30, the VIX term structure is very steep. Participants seem to be anticipating another round of volatility in the months ahead. But just how quickly can term structure change? Figure 4 below shows the situation on October 3, 2011, when the market appeared to be bottoming out. The longer-dated VIX values were elevated and in the mid-30s. But, notice that term structure was sloping the other way. VIX had rallied to the mid-40s at that time, less than five months ago.




FIGURE 4: HISTORICAL TERM STRUCTURE Compared to current term structure, the VIX was telling a different story about volatility in October 2011. The back-month VIX readings at the time showed future volatility coming down, which is what happened. For illustrative purposes only. Past performance does not guarantee future results. Source: CBOE.

Headline Risk

If there is some global risk premium priced into the term structure of S&P 500 options, it makes sense to pay attention to the headlines, both in the U.S. and abroad. On March 6, 2012, the Dow Jones Industrial Average lost 204 points and suffered its biggest loss so far in 2012 after investors shed risky assets globally. Germany’s DAX and France’s CAC 40 both suffered one-day losses of 3.5% from concerns about a shaky deal between deeply indebted Greece and its creditors. A mini-wave of fear and contagion suddenly surfaced and spread across global equity markets. At the same time, VIX rallied 2.70 points, to 20.75 on March 6, before suffering a four-day, 25% slide, thus erasing the entire gain and a lot more. As of early March, 2012, the index is falling towards 15, its lowest levels since late-May 2011.

The S&P 500’s low level of actual volatility, hovering around 10%, appears to be one reason VIX is falling. There’s not much volatility in the market today, and VIX is responding. Still, while VIX seems to reflect expectations that the low levels of market volatility may continue, headline risk is a reality. The steep slope reflected in the term structure of VIX future values seems to be telling traders to stay on their toes.