After a healthy correction of 10% from the top the question in everyone’s mind is the following:
At what level will VIX reset ? In other words, after years of low VIX values what would be the new normal level? 12 ? 15? 20 ? Of course it is hard to come up with an estimate right now but looking at certain immediate statistical measurements can provide us with good clues.
We all know that VIX trades at a small and consistent premium over realized volatility during peaceful times, however after a volatility event the opposite becomes true, VIX starts to trade at a discount over recent realized volatility. For today for instance, realized variance in the past 30 calendar days is around 25.5% and VIX is trading at 25.26% so already we are seeing a small discount which will get bigger as time passes. But how much more discounted can it get ? The problem is that it would take a lot of time for past realized variance to normalize because enough time has to pass to get the event out of the computation window (at least 16 trading sessions as of today) which is about 3 full weeks. Of course we don’t want to wait that long to get an idea of where VIX will be in the near term.
To solve that problem the next best clue is provided by intraday realized volatility. Again, VIX tends to trade at a small premium over daily realized vol as well, in this case for today we are seeing intraday realized volatility hovering around 15% and decreasing so we could assume that VIX will tend to settle at a similar level. Of course we only have one data point but if we keep track of intraday volatility for the next few sessions we can get a good sense of where VIX will finally land after the commotion is over. If the current 15% or less level remains in the market for several sessions in a row then VIX is in for a nice collapse of more than 10 vols in the near term.