Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / Why the VIX at 16 Hides a Steeper Premium Problem
Transcript
- Lucas: The VIX is at 16.32 today. That is up 8.6 percent over the last five days, but it's still below the long-term median of around 17.5. So the headline is basically 'low-ish volatility, mildly rising.' Luna: But the VVIX is at 95.69 — up 9.6 percent over the same period. That is a much bigger deal relative to its own history. Lucas: Exactly. The VVIX is the VIX of the VIX — it measures the implied volatility of VIX options. And 95.69 is in the 85th percentile of all closes since inception. The VIX itself is only in the 45th percentile. So you have a strange spread: the VIX says 'moderate fear,' but the VVIX says 'we expect the VIX to swing violently.' Luna: That feels like a mismatch. If traders expect the VIX to spike, why isn't the VIX already higher? Lucas: Great question. Part of it is the shape of the volatility surface. The VIX is a 30-day forward-looking measure based on S&P 500 options. Right now, those options are pricing in a relatively calm next month. But the options on VIX futures — which is what the VVIX tracks — are pricing in a much wider range of outcomes for where the VIX itself will be. It's like saying 'the weather next week looks fine, but the forecast models have huge error bars.' Luna: So the VVIX is basically saying 'the VIX could be way off.' Lucas: Right. And historically, when the VVIX is this elevated relative to the VIX, it tends to precede a VIX spike within a few weeks. Think of it as a leading indicator for a vol event that the VIX itself hasn't priced in yet. The last time we saw a similar divergence was in late 2019, just before the COVID crash in 2020. The VIX was below 15, the VVIX was north of 90. Luna: That is sobering. So what does this mean for someone who's holding a portfolio right now? Should they be buying puts? Are they expensive? Lucas: That's the tricky part. S&P 500 puts are actually reasonably priced in terms of outright premium — the VIX at 16 puts them around the 18th percentile of cost over the last five years. But the VVIX being high means the cost of VIX call options — which are a common tail hedge — is elevated. If you're trying to hedge by buying VIX calls, you're paying up. The market is already pricing in that a VIX spike is likely. Luna: So the tail hedge is itself expensive. That mirrors what we saw in early 2020 — VIX calls were rich weeks before the crash. Lucas: Exactly. And that is the dilemma. If you buy VIX calls now, you're paying a premium that already assumes a spike. You need the VIX to go up a lot — maybe above 30 — just to break even. Meanwhile, if you buy S&P 500 puts, they're cheaper, but they only protect you if the market actually drops. And the VIX can spike even if the S&P only falls 2 or 3 percent, because vol tends to overshoot on the downside. Luna: So what is the play? Do you do nothing? Do you buy puts anyway? Lucas: I think the smart move is to look at the shape of the put skew. Right now, out-of-the-money puts on the S&P 500 are relatively cheap compared to at the money puts. The skew is quite flat. That means tail puts — say, a 5 percent out-of-the-money put — are historically inexpensive. That is a better hedge than VIX calls, because you're not paying for the vol of vol premium. You're just buying direct downside protection at a discount. Luna: Interesting. So the VVIX is telling you that VIX hedges are crowded, but the VIX itself is telling you that S&P tail hedges are not. Lucas: Precisely. And that is a classic sign that the market is pricing a tail risk event through the vol of vol channel, not through the index vol channel. It happened in 2018 with the volmageddon episode, and again in 2020. Both times, the VVIX ran up weeks before the VIX popped. So if you're managing a portfolio, this is a good time to check your exposure and maybe add some cheap tail puts. Not because we know a crash is coming — we don't — but because the options market is essentially offering you a discount on one type of protection while charging a premium on another. Luna: And the discount on tail puts is exactly because the VIX is low. That seems like the right asymmetry to exploit. Lucas: Yeah. The market is saying 'the base case is calm, but the range of outcomes is wide.' If you can buy protection that pays off in the wide outcomes without paying for the base case, that's a good risk-reward. And that is essentially what a cheap out-of-the-money put does. Luna: Let's talk real numbers. The S&P 500 is at 7,550 today. A 5 percent out-of-the-money put would be around the 7,173 strike. What would that cost? Lucas: A 30-day put at that strike is probably going for about 0.7 percent of notional — so on a $100,000 portfolio, that's around $700. That is historically cheap for that level of protection. Back in 2020, similar puts were trading at 2 percent or more. So you're paying less than half the long-term average for catastrophe insurance. And the VVIX is telling you that the catastrophe is more likely than usual. Luna: That is a compelling argument. But what about the person who says 'I'll just ride it out, I'm in it for the long term'? Lucas: Fair point. If you have a long time horizon and you don't want to trade around volatility, then ignoring the VIX and VVIX is fine. But the problem is that big drawdowns have a way of making people panic-sell at the worst time. Having a small put position can act as a behavioral circuit breaker — if the market drops 10 percent, your puts are up big, and you can rebalance into the downturn without the emotional pain. That is actually the best use of tail hedges: not to time the market, but to give you the confidence to stay disciplined. Luna: So it's not about predicting a crash. It's about having a plan that works in multiple scenarios. Lucas: Exactly. And the current vix vvix setup is one of the clearest signals we have that the market is underpricing some tail risk while overpricing others. It pays to be aware of it. Luna: Speaking of things that underpin good decision-making, I want to mention something quickly. A bunch of listeners have asked how we keep this show going without ads or sponsors. Lucas: Yeah, it's a good question. The answer is straightforward: a small but dedicated group of listeners chips in monthly through buy me a coffee dot com slash fexingo. That's it. No ads, no corporate overlords. Just listeners who find the conversations useful and want them to keep happening. Luna: And we're really grateful. It's what lets us do deep dives on things like VVIX spreads without worrying about selling something. If that sounds like your kind of thing, you know where to find us. Otherwise, no pressure — the show stays free either way. Lucas: Right. Back to the vol story. So to wrap up: if you look at the VIX today at 16.32 and think 'no big deal,' the VVIX at 95.69 is telling you to look a little deeper. The tail-hedge market is pricing in a storm, even if the index market isn't. That tension usually resolves with a spike in the VIX. When and how big — nobody knows. But the asymmetry is tilted in favor of cheap protection right now. Luna: And the protection that's cheap is the direct index put, not the VIX call. That's the actionable takeaway. Lucas: Yeah. Let's see if the market proves us wrong — that's the fun part. But having the framework is half the battle.