Tag Archives: volatility

Inverse Relationship Between Stock Prices and Volatility

Right now, even I don’t fully understand how markets work. I’m getting better, but still not where I need to be. There are two accounts under my control: a simple one that allocates an equal amount of money into 30-yr treasuries and a retail ETF, which has done well with annual returns of about 50%; and second, a more complicated mixed portfolio, which has not done as well as I had hoped due to the mistake that I explained yesterday. The gap between the better hypothetical portfolio and the my own is around $2,700, up from $2,000 yesterday. A disappointment. I still don’t fully understand how volatility works, and very, very few people – if any – understand the intricacies of volatility futures and mean-reversion delay. If you think volatility is complicated, futures add a new level of complexity. Generally speaking, as the market plunges, volatility rises. Normally, the inverse geometric * relations hold. But when volatility rises too much, like it did on Monday, there is a lag between volatility and stock prices, meaning that stocks can fully recover quickly but volatility may remain very elevated. So not realizing this caused me to misappropriate resources by being short volatility when I should have bought stocks.

* Rather than computing correlation coefficients, it’s easier and more effective to simply analyze the the two charts (the underlying index (S&P 500) and volatility futures) at the extremes:

The lag tends to be much less, or even non-existent, for smaller spikes in volatility. Also the lag tends to come later and not after the initial spike in volatility.

If the market crashes again, I am not going to make this mistake again. I’ll have a better strategy specifically for that situation, and then switch back to something else.