Is It a Good Time to Buy Options?

Friday was quite the ugly day in volatility land. With the S&P 500 (SPX) up a
mere 0.26%, we saw the VIX tumble 7% to 18, which is about what we saw post
flash crash. Part of this can be explained away by the fact that traders often
lower options bids on Fridays ahead of weekend decay. In addition, we had a big
news event pre-open with the very disappointing jobs number. When there is
nervousness about the market gapping, options are bid up ahead of it. Think
about Apple Inc. (NASDAQ: AAPL ) ahead of earnings. Once earnings are announced,
whether the stock goes up or down, AAPL options volatility will decline. So
perhaps some of Fridays VIX decline was a sigh of relief that the market
recovered after selling off on the jobs report. On the other hand, this heavy
VIX does not make sense given that implied volatility is rather low right now
compared to realized volatility. The graph below shows 10-day historical
volatility in the SPDR S&P 500 (NYSE: SPY ) over the past three months, which
sits at about 17.5 now. The next graph shows 30-day implied volatility in SPY
(yellow line) versus 20-day historical volatility (blue line). If you squint,
you will notice that for the first time since around Labor Day, 30-day implied
volatility is now slightly lower than 20-day historical volatility, and a full 2
points lower than the noisier 10-day historical volatility. In other words,
options have gotten objectively cheap. So should you buy the iPath S&P 500 VIX
Short-Term Futures ETN (NYSE: VXX ) and/or SPX or SPy options? Alas, its never
that simple. Historical volatility looks backward, whereas option prices
anticipate future volatility. Options pricing is affected by past fluctuations,
but thats just one factor taken into consideration. Right now options anticipate
that market volatility will begin to taper off. Part of this may simply be due
to the time of year. December does not tend to bring Christmas cheer to the VIX.
In fact, it is the worst cycle of the year. Remember that the VIX prices options
30 days out, and as of right now that includes the full chunk of the slow week
between Christmas and New Years. While the reasonable price structure makes it a
less-than-awful time to own options, I wouldnt go hog wild here given that the
calendar should start weighing pretty heavily on realized volatility.