The map below shows a snapshot of the volatility risk premium in major equity indexes around the world, with charts showing the last four months of data for the current highest- and lowest-ranking countries.
Source: Condor Options
The volatility risk premium is measured here as the ratio of one month implied volatility and one month trailing realized volatility. A high (low) estimate indicates that options have been expensive (cheap) over the past month relative to the actual volatility exhibited by the underlying stock index. Past premium levels aren’t necessarily indicative of future levels, as you can see in the time series charts, but volatility effects do tend to cluster and it’s always helpful to know where options are the most and least expensive.
One wrinkle in any attempt to make comparisons like this is that some indexes exhibit much more volatility than others. Emerging market stocks, for example, tend to move more dramatically than equities in developed markets like the U.S. or France. Some of those differences are smoothed away by using ratios of each country’s implied and historical volatility, but to make the comparison even better, we look at the percent rank of each ratio versus the last two years of observations.
Right now, the S&P 500 (SPX) ranks the highest out of the twelve countries in this group, while the S&P/ASX 200 (Australia) comes in last. With some important data releases still to come this week, it’s likely we see a reversal lower in the level of SPX implied volatility relative to the movement in the underlying: an ill-received Fed comment or two could push stocks lower, sending realized volatility up even as the reduced short-term uncertainty means option IV declines; if the Fed day goes well and NFP comes in as expected, we could also see option premiums drop. We’re positioned right now with bullish equity positions for the medium term and hedged for this week with a long SPX strangle.
By Jared Woodard
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Jared can be followed on Twitter at twitter.com/CondorOptions.