By Greg Jensen
When most people think of a volatility index, they think only of the big boy, the CBOE Market Volatility Index (VIX), which measures implied volatility in options on S&P500 stock. There was a time when the VIX was an options insiders secret, used almost exclusively as a hedge by floor traders. As its usefulness became better known, the VIX became a tradeable instrument in itself, offering leverage to bears everywhere. The success of the VIX has resulted in volatility indices being available on a range of other instruments; the CBOE Gold Volatility Index (GVZ) is a good example. As you would expect, this measures the volatility of gold.
With the recent rapid decline in gold prices, GVZ reacted just as you would expect from a volatility index. It went nuts.
From the beginning to the middle of April, GVZ tripled in price. That, and the subsequent decline, is now history. Those of us that missed the initial move, however, may still have an opportunity to profit from GVZ.
The VIX and other similar instruments are known as “fear indexes”, and for good reason; they respond quickly to fear of a total collapse. The thing about fear, in any of its myriad forms, is that it is persistent. It lingers. This lingering unease is what presents an opportunity, even after the fact.
Look at the chart above for the VIX. The chart looks like a series of escarpments to anybody who took High School geography. For those that didn’t (or didn’t pay attention) an escarpment is a land formation with a steep slope on one side and a gradual one on the other.
In financial markets, as in any walk of life, fear arrives quickly and dissipates slowly. Even as the evidence mounts indicating that the danger is over, a persistent uneasy feeling remains.
The evidence of the last month would indicate that the panic in Gold is over, yet GVZ remains elevated, closing yesterday at 19.92 compared to a price around 12 before the collapse.
Of course, past performance is no guarantee etc. but GVZ would seem to be following a familiar pattern for volatility indices; quick to spike, slow to fall. Given the price action in gold since, though, it looks like it will fall. Shorting GVZ at these levels with a target of around 13 may not be as sexy as being long just before the big move, but, to me, the return to normalcy looks a little more predictable.