VIX vs. Political Volatility - 2013 Edition

Political volatility is BACK. The U.S. government could shut down and default in October. These reposts told you everything you needed to know. I specifically looked at the VIX in this post (CBOE Volatility Index), which measures the expected volatility in the S&P 500 over the next 30 days via its option prices.

*UPDATE: US Government Shutdown Likely Over Obamacare Row
*US Government Shutdown Threat Casts Cloud on Stocks
*Just What Happens if US Government Shuts Down?
*40% Odds of a U.S. Shutdown and Default: Guggenheim Partners Analyst Chris Krueger

The VIX rose 17.8% last week to 15.46 on all of this political uncertainty, but it's still relatively low. There is also an interesting gap between the VIX and the VIX's VIX ($VVIX) right now (chart below).
At the end of 2012, when we were nearing the edge of the fiscal cliff, the VIX rose significantly because traders were worried that fiscal tightening would affect the market. VIX call activity actually predicted that the VIX and VVIX would rise through year-end 2012. However, when congress eventually struck a deal on the fiscal cliff, the VIX ended up crashing not the S&P.

Source: (green = SPX, red = VVIX, blue = VIX)

As noted in my previous post on IRX (3-Month T-Bill Rate Index) versus SPX (S&P 500 Index), if we relive 2011 all over again (congress raises the debt ceiling and the U.S. gets downgraded; or, the U.S. doesn't raise the debt ceiling (fund the government), gets downgraded (?) and enters into technical default status), the market could sell off pretty hard. However, this time around the Fed is injecting $85 billion into the system every month. So it's really up to the "big boys" to decide what the next downside catalyst will be since bad news equals good news with the Fed's put still in place (QE). But all of this uncertainty probably explains why the 3-Month Treasury Bill yield made a new low last week (chart vs. S&P).

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