The old saying in risk management is to buy protection when you can, not when you have to. Throughout this year, we’ve been intentionally opportunistic in flagging when the volatility market presents attractive risk-reward opportunities to add long vol exposure. Today, our indicators once again signal a favorable tactical setup to go long volatility.
To be clear, in terms of the 6-month forward cyclical outlook, our macro risk models and leading indicators are still showing a benign risk-on backdrop (see our October Macro Snapshot), so this note is NOT about a major asset allocation shift. Instead, the focus of this note is to flag an attractive set up for more tactical portfolios.
Our tactical “complacency” signal has triggered again for US equities. We define “complacency” as when the S&P 500 is not reacting to rising risk signaled by 10y Yields, the VIX or the MOVE over the past 1 month. The below signal is triggered when the coefficient and R^2 of the rolling regression of daily changes in the S&P 500, VIX, MOVE and 10y drop below proprietary thresholds.
US single-stock implied volatility is now very elevated relative to the S&P index volatility, with the gap surging to multi-year highs.
This has occurred because implied and realized correlations are very low. Elevated single-stock volatility is being masked at the index level by unusually low correlations. This creates a fragile set up for potential spikes in index volatility. Correlations are already near historical lows, so there is limited room for further compression. The risk now lies in a rebound in correlations, which would translate into higher volatility at the index level.
In terms of hedging structures, we like November VIX call spreads offering a 6:1 max payout:
- Buy 1x VIX 20 Call 11/05/2025 Expiry
- Sell 1x VIX 25 Call 11/05/2025 Expiry
This covers the majority of US earnings season and the October Fed meeting.
On current evidence, we think a call spread is likely sufficient as any volatility spike will probably be moderate. We do not yet have cross-asset confirmation from our main VP Correction Signal, which looks for breadth of deterioration across credit and cross-asset volatility markets.
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Our VIX fair value model also suggests the VIX is not egregiously mispriced right now given where realized volatility is.
