When the VIX Reads SPX Option Volatility Incorrectly

If you were one of my option mentoring students, or a regular reader of the Option Pit Blog I think you know what I am about to write.  The VIX was really wrong today; implied volatility was not down the 2.18% that the VIX was telling us.  That is probably clear when you are looking at your trading P&L today.  But how much did IV really move?

Yesterday the Curve looked like this:


I highlighted the 1200's so that the reader can see where the IV was trading yesterday.  Notice that the 1180's are definitely a higher implied volatility than the 1200's.

Here is today's curve:

notice that the 1200's implied volatility fell only about .75 of a percent in December.  January fell even less, on the 1185 line, January fell less than .25 of a percent, December fell more like .60 of a percent.

This is the problem with a vega weighted volatility average, it is also why traders that want to play in the options game really need to understand volatility and what the VIX really represents.  In the end, adjusted for price, implied volatility was in less than a point.  If we were trading 1185, the VIX would likely have read down about .75%.  I have gone through the description of how the VIX operates on several occasions read one here.  If I didn't do a good enough job, check out Bill Luby's blog.

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Graph from livevol


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