Hello everyone, welcome to a new part of Unusual Whales where we answer random questions from the market, coupled with data. Some posts will be recurring research areas, or entirely new items! I’ll take a stab at trying to answer any questions you guys have, along with outputting some original work on questions we had from the Unusual Whales side of things.

As always, none of this is financial advice in any way, shape or form, and any suggestions herein referencing a strategy are for the sake of the research, and not financial advice. As with all research on the market, current and past trends do not predict or reflect future prices, but may be insightful for future movements, so do your research before you make an investment decision.

With that, let’s get started! 🐳

For the first segment, I wanted to talk about Federal Open Market Committee (FOMC) meetings and market volatility, and more specifically, does the VIX rise leading up to FOMC meetings and what does this tell us?

DISCLAIMER AND UPDATE 12/14/21:

Falcon here, and just wanted to clarify something about this report.

First and foremost, my sincerest apologies. Research such as this is a continual place of learning, and those familiar with the VIX know just how unique and intricate all aspects surrounding it are. There are things I happened to overlook, but my basis for it is mentioned below.

The results of this study lacked some insight into how the functioning of VIX calculations worked. I had originally assumed that since VIX was derived off of SPX futures, that the effect I had found would hold up. It was pointed out to me by a twitter member that the results in this post are simply a data artifact of what is called "the weekend effect" and is largely due to the VIX being calculated off of a full calendar year, rather than trading days.

The weekend effect can cause a sort of "jolt" as it resets come Monday's open, hence the heightened spot price of the VIX on Mondays.

That's not to say this research is invalidated entirely, as there are still some cool bits of information within the article.

That being said, I am working on updating the report with the correct data via VIX futures, and will update this post again when everything is all tidied up.

As always, I hope you learned something new in this article, even if the end result is a work in progress.

In the meantime, we'll keep fighting to make the markets fair, and level the playing field between retail and institutions.

-falcon

Summary and TL;DR

There is a signal! The VIX does rise on a consistent pattern into FOMC meetings. It also consistently drops following the meetings (at 2pm).

• VIX typically trends upwards ~1% 3 days out.
• Consistent fall of ~2% 2 days out
• Gain of ~1.5% running into the meeting.
• One potential strategy:
• Sell an iron condor 2 standard deviations away from the spot price (vix at 18: 12/24 at 2 standard deviations) at 1pm 3 days before the meeting while premiums are high, and sell at close 2 days before to profit.
• Long calls/long puts at the inflection points if one can’t afford the collateral required, or is unsure how to manage risks associated with premium selling.

More information below

What is the VIX?

If you’re unfamiliar with what exactly the VIX is or what it represents, then look no further: The VIX is the Chicago Board Options Exchange’s (CBOE) volatility index, which tracks future volatility (also known as Implied Volatility) of S&P options, and is classified as:

“The Cboe Options Exchange calculates a real-time index to show the expected level of price fluctuation in the S&P 500 Index options over the next 12 months. Officially called the Cboe Volatility Index and listed under the ticker symbol VIX, investors and analysts sometimes refer to it by its unofficial nickname: the fear index.”

It is important to note that VIX options are European style, meaning you cannot exercise the option until the expiration date. They also expire on Wednesdays, rather than your normal Friday cycle. If you’re a nerd like me, here is the whitepaper on how the VIX is calculated. It’s quite an interesting read.

What are FOMC meetings and why are they important?

If you’re unfamiliar with what the meetings are, FOMC meetings are held on Tuesdays, 8 times a year, and review economic and fiscal conditions, monetary policy, and look forward to assessing risks that could affect sustainable economic growth. If you’d like to read more, here is a link detailing information about the FOMC, along with its committee members. Essentially, this is where the powers-that-be meet to discuss several different economic factors, including a huge proponent of the current market structure: interest rates. When interest rates rise, money typically flows out of the economy, since more people are likely to save money to combat inflation. This also means less cashflow for businesses, resulting in lower revenue, and decreasing stock prices. Since interest rates are bottomed out and will be (most likely) for the remainder of 2021, the low yield curve is one of the main pushes behind this insane bull market and the constant “melt up” as of late.

Here is an excerpt from the link above addressing the purpose of the FOMC.

“The term "monetary policy" refers to the actions undertaken by a central bank, such as the Federal Reserve, to influence the availability and cost of money and credit to help promote national economic goals. The Federal Reserve Act of 1913 gave the Federal Reserve responsibility for setting monetary policy.

The Federal Reserve controls the three tools of monetary policy--open market operations, the discount rate, and reserve requirements. The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee is responsible for open market operations. Using the three tools, the Federal Reserve influences the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks and in this way alters the federal funds rate. The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.

Changes in the federal funds rate trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables, including employment, output, and prices of goods and services.”

If all of that looks like Greek to you, it’s okay, it probably looks like Greek to a lot of fund managers, too.

To summarize: FOMC decides interest rates. When interest rates go up, stocks typically go down.

One of the main reasons behind this research was due to curiosity surrounding a drift into the FOMC, especially with the current options-centric market. FOMC meetings typically cause a rise in volatility, followed by a drop in volatility following the meeting itself. There are many different ways we can try to measure this drop to see if we, as investors, can profit off of it, or even predict it. However, the VIX is a very tricky index since it’s non-stationary, essentially meaning that the component of time does not matter in predicting the movement of the VIX. The level it was at 3 days ago has no correlation to what level it is today, tomorrow, or next week. Due to this component, it leaves a lot of quants and researchers very confused on how to calculate its next move. In these cases, some resort to coupling it with other indicators such as key levels of the SPY, or even looking at Bitcoin price action at certain hours of the day.

Some research with VIX and FOMC meetings suggest that drops in the VIX following FOMC meetings is due to the alleviation of uncertainty in interest rates or other fiscal policy which is the most likely scenario, while others attribute it to a mechanical response (as simple as: it always drops after meetings because that’s how the market works), such as Savor and Wilson (2010) and Nikkinen and Sahlstrom (2004). Either way, this tells us that researching the VIX is very complicated, and results from research may vary quite drastically.

There is also research done on returns prior to FOMC meetings, such as the work done by Lucca and Moench (2015), which shows that the 3 days before an FOMC announcement returned ~.6%. Granted, this was in a time before a meteoric rise in options trading, so research after that date could help us to explain more about options.

Here are my findings

Since there is so much speculation surrounding the VIX, and even more so now considering the massive ?! surrounding interest rates, I wanted to examine the relationships that the VIX had with FOMC meetings from 3 days out.

First I started by overlaying FOMC meetings with VIX data as a graphical representation. 2020 was a lot of fun as we can see.

From the chart above, you can see some visual movement following FOMC meetings, most notably in 2016, early and late 2018, and 2020. If the chart of the VIX looks wonky to you after 2018, it’s due to Volmageddon and can be explained by the linked article. Unfortunately for the research, just this graphical representation cannot tell us much, but it shows us there is fairly drastic movement at times following the FOMC meetings, and most of the FOMC meetings have some form of runup to them.

I wanted to check the velocity of the changes in the VIX so added a 10 day window moving average along with an average value for that day and took the standard deviations on a 10 day window of both of them, then took the differences between standard deviations. This should give us a fairly good approximation of how drastic changes in the VIX are, particularly around certain news cycles.

Okay, cool. Visually analyzing the chart shows a few fairly drastic movements in the VIX during the days following meetings, meaning there could be a minor signal there. We can see how the differences between the moving average standard deviation and the average standard deviation are represented below, but this is rather nerdy. From this chart, though, the average standard deviation seems to be a more reliable indicator of seeing when stuff is really hitting the fan.

Now for the real question: Is there a run up to the FOMC?

Disclaimer: the data is just hourly VIX average values, so true results with minutely data may tell a different story… but that is future research.

There is a trend

We can see the VIX typically rallies ~1% 3 days out with a consistent fall of ~2% 2 days out, and a gain of ~1.5% running into the meeting. The day after the meeting, we see it rise ~2.5% at the peak. Assuming one goes long/short at the major inflection points, that’s 7% worth of movement told to us by this data. That may not seem exciting, but remember how far 7% can go over the years. One could sell an iron condor 2 standard deviations away from the spot price (vix at 18: 12/24 at 2 standard deviations) at 1pm 3 days before the meeting while premiums are high, and sell at close 2 days before to profit, or just go long calls/long puts at the inflection points if one can’t afford the collateral required.

One thing to note is that the VIX sharply declines following the meeting itself at 2pm on the day of the meeting. There are speculations for this movement, such as a mechanical drop. This approach, personally, doesn't make sense, and it's much more likely that the drop in the VIX following meetings is attributed to investor/institution based concerns alleviated surrounding fiscal policy.

My findings aligned fairly well when compared to those with Lucca and Moench (2015), but the VIX remained flat overall through the 3 day stretch, if you discount daily movements.

More nerd things

The chart below shows us the average range of the VIX on those days. The most notable range was T-2, where there is a consistent downward trend. It looks like this range increases dramatically in the middle of the day on T-3, T-1, and also consolidates for the morning on T+1. The trend on T-2 would be the ideal one to trade, as it is the most consistent.

Final thoughts:

If an investor has a lot of leverage, they can play these strategies fairly safely. However, does this answer the question of: Does volatility rise into FOMC meetings? Yes, it does, but further research is required into how we can effectively play this strategy.

DM me on Twitter @falcon_fintwit if you have suggestions for further research, or if you have any questions about methods. I would love to hear them!