The VIX Has Very Little Room To Fall Even If The VIXEQ Rises

Stocks finished the day higher ahead of the Fed minutes. I don’t know what those minutes will tell us, but the market has apparently liked the forward guidance from Williams and Jefferson last week, which suggested patience and fewer hikes than the market had been pricing in. So maybe Warsh can use those minutes to communicate a more hawkish vantage point for the rest of the committee. It would be a turn of events if that were the case.

The implied volatility of the VIX is fairly low and at a point where it is either going to bounce, or we are going to see it fall to 2024-like levels, last seen in June and July of that year.

Meanwhile, we are approaching that time in the cycle where we should see single-stock implied volatility rise. A big reason the VIXEQ rose so much last quarter was the big move in semiconductor implied volatility, so I don’t think we will see it nearly as high as we did in July. I think 45 is possible, but I would be really surprised to see 50.

That would probably be a problem, because if the VIXEQ only rises to around 45 and implied correlation is at 8, there just isn’t as much room for the COR1M to fall this earnings season. In March, the COR1M was nearly 42, and in June it peaked at 17.8. So unless implied correlation rises sharply between now and next week, there isn’t very much room for it to fall. In fact, if COR1M stays around 8 and VIXEQ rises to 45, the formula is SQRT(COR1M) × VIXEQ, and that spread stays in the 4-point range; then the VIX would be around 17.

Could the COR1M fall further? It did get down to 3.4 in July, but that came with the VIXEQ near 50, driven by the semiconductors. If the VIXEQ tops out closer to 45 this time, a drop that deep seems unlikely. And even if it happened, it would take only about 3 points off the model VIX, versus roughly 10 points last quarter. A more modest decline in correlation, to around 6, would leave the model VIX roughly where it is today.

It will depend on how high dispersion in the index can get ahead of earnings, but since dispersion and correlations are already starting out fairly stretched, there may not be much to add.

-Mike

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Glossary by ChatGPT

COR1M — A one-month implied correlation measure reflecting the market’s expectation for average correlation among index constituents.

Dispersion — The degree to which individual stock returns vary relative to one another, often creating opportunities when constituent volatility diverges from index volatility.

Forward Guidance — Communication from a central bank intended to shape market expectations about the future path of monetary policy.

Implied Correlation — The correlation among index constituents implied by the relationship between index options and individual-stock options.

Implied Volatility — The level of future price variability embedded in option prices.

Model VIX — An estimated VIX level derived from inputs such as single-stock implied volatility and implied correlation rather than the observed VIX itself.

VIX — The Cboe Volatility Index, which measures option-implied expectations for S&P 500 volatility over approximately the next 30 days.

VIXEQ — A measure of aggregate single-stock implied volatility used to assess equity volatility independently of index-level correlation effects.

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