Understanding the Seasonality of Implied Volatility

When you think about trading all day, every day as I do, everything seems to come back to puts and calls in some way, shape or form. We all just celebrated National Dog Day, whereupon I, of course, immediately made a connection to options. Specifically, I recognized how this holiday fit into my understanding of the seasonality of options implied volatility. Let me explain some of what I know about this phenomenon, and then I'll share how this knowledge might help shape your trading decisions.

What Is Seasonality?

Seasonality refers to measurably predictable patterns and changes occurring over a calendar year, which is split into four quarters (seasons). Seasonality can be used to help analyze stocks and economic trends and can be another tool used for predicting future price action of futures and equities. The jury is still out on whether options implied volatility can be profitably forecasted based on the season. A few observations can be made, however, that are data-based and therefore indisputable. Allow me to weave these facts into my explanation below.

Summertime Trading Trends

Going back to National Dog Day, I noted that whoever chose Aug. 26 as the date to honor our canine best friends did a very good job. National Dog Day just so happens to come at the end of the aptly named dog days of summer. Equity and option volume during the summer months is usually lower than most other times of the year. Implied options volatility as measured by the VIX historically hits a yearly low during these summer doldrums before beginning an ascent that usually lasts all of autumn.

August often finds many trading firms short on staff as it is a popular time to take a vacation. However, as traders and investors return after Labor Day, they begin to note sunset coming earlier and the nights taking on a characteristic cool crispness. As the leaves start to change colors, many begin to feel trepidation and/or excitement with respect to the markets, often culminating in increased implied volatility levels in the S&P 500. Many market prognosticators get goosebumps because they recognize that the market is entering what is known as the “season of the witch.” Scared yet?

Autumn Trading Trends

The season of the witch refers to the spooky Halloween season, of course. Another market-related term has been applied to this period, Octoberphobia. Traders have come to associate October with the crashes of 1929 and 1987. Much wringing of hands and gnashing of teeth occur during this time of year. The data, however, tell a bit of a different story.

It turns out the fear associated with the season of the witch is a bit overdone. While it is true that a predictable pattern of VIX price acceleration occurs annually from August to November, there is no statistical evidence that October is a typically down month for the overall market when measured on a monthly basis. In fact, I went to several sources and used CBOE data since the inception of the Volatility Index in 2004. I found that on average, the VIX does not show any discernible trends by any season of the year. It's all random.

Final Thoughts

Actually, the VIX, otherwise known as "the fear index," is a lot less predictable than thought by many. Franklin Delano Roosevelt proven right again with his famous line, "the only thing we have to fear is fear itself." Why not use the insight you gained today to incentivize yourself to take a deeper dive into this topic? Maybe consider backtesting different strategies so you can then trade with even more confidence. It will be time well spent.

Joe Leska, Market Taker Mentoring

Trader Education