The normal state of affairs is that 1-month expected volatility (i.e. VIX) is lower than 3-month expected volatility. In many ways this is similar to short term interest rates being lower than longer rates. The logic is that a lot more grief (random or otherwise) can happen over the long term and the market prices that in.

Let us suppose you believe that expected volatility is forward looking (the standard belief). Should you happen to find yourself in the (less common) situation where the market has priced 1-month expected volatility higher than the 3-month, the logical conclusion is that the market places a higher risk on the near term. Since higher levels of expected volatility tend to be bearish, your subsequent conclusion is that the market will get its butt handed to it fairly soon.

Hey, that means you could simply take the difference of the two expected volatilities. Sounds great, but the levels of 1-month and 3-month expected volatilities are not directly comparable. To make them comparable the geek/data monkey has to normalize them over the most representative period. To further complicate this, the last item (the representative period) is never static, but variable. However all of the above are minor items that can be dealt with.

Now the question is: Why am I telling you this NOW? Go figure.

N.B. I am deliberately choosing not to show this in chart form.


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