Gillian Tett takes a look at the VIX today:
Last week, for example, a record 1m Vix options contracts changed hands on one day after a spate of bad news from Japan and the Middle East. This beats the previous daily record of 715,000 contracts recorded in December 2009 and is several times the level of anything seen even during the crisis of 2008…
In theory, this could potentially be very beneficial for the market. After all, the more liquidity that exists in any product, the more accurate prices are likely to be and the smoother any adjustments. And the Vix certainly does provide a powerful barometer of sentiment that can be quickly grasped by investors (or journalists) alike…
But as sociologist Donald Mackenzie points out in his book An Engine Not a Camera, when new financial measures and models emerge, they do not simply offer a “snapshot” of activity, they can drive behaviour and change it too.
If 1 million contracts changed hands with the VIX at 30, that’s a total contract volume of $30 billion in one week. (One contract is $1000 times the VIX.) Annualize that, and you get to over $1 trillion a year — we’re talking real money here.
(Update: As gbojangles points out in the comments, Tett was talking about VIX options contracts, not the VIX futures contract. My bad. The options contract is $100 times the VIX, not $1000, so total volume is nowhere near the $1 trillion-a-year level.)
Tett concludes that “creating the Vix has been beneficial,” on the grounds that “more transparency is good.” But I’m not sure I buy this argument: trading volumes don’t increase transparency, and it was always possible to measure the implied volatility of the stock market long before it became a futures contract. The prices of the VIX are always accurate, and not particularly interesting: they’re just the implied volatility of the S&P 500.
(Update: Since we’re talking options not futures here, the options price does actually have new information: it’s an indication of the volatility of volatility. Why this is something we need to know, I’m not entirely sure.)
I suppose it’s true that with the VIX turned first into a futures contract and now into various ETFs, it’s become much easier to see at a glance just how volatile the S&P 500 is. Stock prices, after all, are much easier to find than implied probabilities. Maybe one of the reasons that nobody much looks at the TED spread any more is that it never got turned into a product.
On the other hand, I don’t really buy Tett’s point about reflexivity, either — the idea that the VIX tail could end up wagging the S&P 500 dog. Her examples from the CDS market aren’t especially relevant, because CDS-based indices were based on highly opaque underlyings — contracts and credit spreads which were pretty much impossible to find in public. The VIX, by contract, is based on one of the most liquid underlyings in the world, and it’s highly unlikely that a lot of VIX trading activity — even in the trillion-dollar range — would actually affect stock prices.
My feeling is that the rise in VIX volumes is dangerous mainly to the people trading the VIX, especially in ETF form. From a systemic perspective, there isn’t much to worry about. But neither is there anything to celebrate. Individual investors and the financial media have a distressing tendency to concentrate mainly on ticker symbols when looking at the markets, and to ignore indicators which can’t be expressed in that form. Now that the VIX is a ticker symbol, it’s getting a lot of attention. But the problem isn’t with the CBOE’s futures contract. Instead, it’s with a mindset which discounts indicators which aren’t easily tradable. And that mindset, I’m afraid, is here to stay.