FxWirePro: Implied thought on implied vols and trade ideas

A lot of what we had expected has come to fruition so far in 2017, even if we had not expected the sheer magnitude of the depression in equity volatility, which continues to be the single most salient feature of volatility markets YTD. Low vol continues to baffle investors and support financial conditions, but investors are becoming increasingly cautious.

As per Societe Generale, in this note, we revisit the low vol debate, but also carry out an appraisal. We look back at the themes and trade ideas we have highlighted so far in 2017 and aim to learn lessons from what has worked and what has not. 

1) Short VIX trade – a plane flying on one engine breaking down the returns from short/inverse VIX trades shows us that two out of three factors behind large returns are not likely to get significantly better. We believe that stock replacement is better than selling vol.

2) Variance swap spreads are tortoises: We highlight that in a low vol environment, it may be prudent to focus on the trend in realized volatility, as many factors can distort the implied vol trends. If the realized trend is profitable, then slow and steady should win the race.

3) The recipe to generate profits from uncertainty: We revisit a successful theme in recent months – the bucketing effect in vol around an uncertain event. We highlight that, if identified early enough, this theme has consistently generated high and steady returns.

4) Buying volatility on Japanese equities – the other widow-maker? It is probably difficult to overemphasize the death of volatility on Japanese assets (especially equities). We highlight the lessons learned from trying to buy vol in Japan.