Trader Talk

Tame VIX shows market may throw (short-term) taper tantrum

Pisani: Volatility expected in coming day

I've been noting for several days that futures for the Volatility Index (VIX) are in backwardation...that is, the front month contracts are higher-priced than contracts farther out.

This indicates that some traders are expecting short-term volatility (around the Federal Reserve meeting) but are expecting things to calm down fairly quickly.

Getty Images

The December contract expired this morning, but this is what it looked like at that time:

December 16.23

January 15.35

February 16.20

March 16.89

April 17.34

If you believe that VIX futures are an indication of how scared traders are about the future, the very gentle upward slope would suggest that traders are not particularly worried about the least in the coming few months.

Why is the VIX so low, given that tapering is imminent? Perhaps because, since May, the Fed has done a better job of communicating its intent to keep interest rates low for a very long time. The budget deal took away a lot of the shutdown risk, which was another source of volatility.

One thing is sure: upward spikes in volatility contracts are met with selling. It seems as if a lot of traders have an excess inventory of protection and are perfectly willing to sell it.

The market is telling you that whatever uncertainty is there, there is not a big justification for immense volatility. The market seems to be expecting a slow, gradual taper. I have no doubt that, when the Fed does announce a taper, we will see a spike up in volatility, and the market believes that as well. That said, it doesn't seem to believe that it will last long.

The pace of tapering is (to coin Donald Rumsfeld's famous phrase) a "known unknown," but as a "known unknown" it seems not to be a big worry to those who buy protection.

Of course, volatility can go up if the Fed fails to pull off an 'elegant' taper. If Bernanke, for example, says "We are beginning our taper today, and expect it to end in March," the market would be surprised-- and the VIX would certainly shoot up over 20.

Clearly, the market is not expecting that at the present time. The market is telling the Fed: "you are managing our expectations right now. Don't screw it up."

By CNBC's Bob Pisani