VIX is plummeting but market reality may yet pull it higher

[SINGAPORE] Wall Street's "fear gauge" is defying the recent market swoon.

The Cboe Volatility Index, known as the VIX, has fallen eighth of the past 10 trading sessions, dropping to 20 on Wednesday versus 36 in mid-December. That's at odds with large realized swings in US stocks - a potentially unsustainable divergence.

"Market internals imply a VIX of 31 based on trailing realised volatility and five-day SPX returns," UBS Group strategist Stuart Kaiser wrote in a note about the gauge's fair value. "60-day realised volatility above 25 per cent is the largest driver of that estimate."

With big down days for the stock market likely, the sizable gap between implied and historic price swings may be untenable, according to Wells Fargo & Co strategist Pravit Chintawongvanich.

"Historically, when VIX diverges this much from realised vol, it usually 'catches up' sometime in the next month," he wrote in a note Wednesday. "The VIX has dropped rapidly as the market rallies, despite high realised volatility. The VIX at 20 is 10 points below one-month realized vol of 30."

Still, a more-dovish US monetary stance, easing trade tensions and improved liquidity compared to late 2018 may justify lower premiums for equity price swings, Mr Chintawongvanich concludes.

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