After Calling April’s Whimpering Volatility Spike, MKM Derivatives Analyst Left Wondering When Shoe Drops

Volatility has been acting “odd,” a research note from MKM Partners observed. Back on March 6, when the research provider made the projection that volatility spike was likely to rise again in the intermediate term, they did so based on historical pattern analysis rather than a fundamental market call. Volatility did jump, but even that relative spike was abnormal.

Forecasting a stock market crash and resulting major volatility spike can be a challenging task

Perhaps one of the most difficult feats in forecasting is accurately predicting a market crash. The feat has been partially accomplished only once when in 2015 JPMorgan’s Marko Kolanovic forecast a flash crash approximately in the middle of a major crash.

Jim Strugger, Managing Director and Derivatives Strategist at research provider MKM Partners knows this all too well. “We think there is no way to be less than spectacularly wrong when forecasting a shock that doesn’t materialize,” he wrote in an April 28 research note titled “Vol Goes Splat.”

When Strugger made his March 6 call that volatility would come back, the underlying VIX index was trading at 11.17. There is no exactly predicting when volatility is going to spike, but after a couple of fits and starts, at the end of the month it rose from the dead. The fundamental backdrop for the move was upcoming French elections and concern over the debt ceiling. By April the fear gauge had risen to 16.19 on April 16.

It matters not the fundamental underlier, however. Strugger relied on pattern analysis with a bent towards near-term statistics. “As always, this view was based on the natural oscillations we expect of volatility and not a fundamental assessment of any particular risk event,” he observed, putting into play the recent pattern of volatility rising then rapidly falling on a 4 to 4.5 month basis.

Even though the market call was relatively accurate, the spike in volatility to just the 16 level seemed odd and non-threatening to Strugger, as if “volatility” could be defined by someone being surprised by a birthday party.