There are just 33 trading days until the stock roller coaster that was 2015 comes to an end. While the S&P 500 (SPX) has muscled back into positive territory for the year—and many measures of market volatility are substantially lower—a few more challengers could poke this bull before the calendar turns to 2016.
Judging by the recent drop in volatility across nearly every asset class, market participants are expecting a relatively quiet stretch through the final weeks of this year. After last week’s jobs report, the CBOE Volatility Index (VIX) dropped below 15 and returned to the lower end of the two-month range (figure 1). VIX tracks the implied volatility priced into short-term S&P 500 Index (SPX) options and is typically viewed as a forward-looking gauge of collective investor expectations.
The decline in VIX is part of a larger theme across the options market. Many measures of market volatility have dropped sharply since September, as the high anxiety about the global economy that drove stocks lower in late August has receded and correlations have fallen sharply as well. The result has been another period of mixed trading with falling volatility.
For instance, volatility on the NASDAQ 100 (COMP) and the Dow Jones Industrial Average ($DJI), as measured by VXN and VXD, are down more than 30% since September. Oil volatility (OVX) and select emerging market measures are down sharply as well. The table below shows the decline across most markets since September, with gold (GVZ) and the euro (EVZ) notable exceptions.
|Since Sept 30
|S&P 500 Volatility||VIX
|NASDAQ 100 Volatility
|Russell Small-Cap Volatility
|Emerging Markets Volatility
|Euro Currency Volatility
|Treasury Bond Volatility
No Light Calendar
Looking forward, a number of events could drive asset allocations and spur ups and downs for the equities market into year-end. Obviously, economic data has implications for earnings, monetary policy, and interest rates. In that respect, a number of reports will shape expectations during the second half of November, including data on inflation, GDP, and manufacturing. Meanwhile, the release of minutes from the October Fed meeting on November 18 could shed light about the direction of interest rate policy heading into 2016.
Through the end of last week, the S&P 500 was up a modest 1.4% year to date. Most measures of market volatility are easing and are now substantially lower for the year. Exchange holidays are approaching, and a lull typically sets in during the final week of the year.
However, expectations for a December rate hike have been building and, to make things interesting, the December 16 rate announcement comes just two days before a volatility-inducing quadruple witching expiration. Witching marks the expiration of futures and futures options on top of stock and index options. That means the big firms may have to unwind many of their stock-versus-futures-versus-options positions, and the net result might be a bit more trading activity, which could heat up volatility.
In short, the ride isn’t over: a few more twists and turns are likely before the typical holiday lull sets in.
Tom White’s RED Option Perspective
Editor's Note: As of October 3, 2016, RED Option is now TradeWise.
SPX logged gains at their strongest in some four years, and the option “premium” has dropped significantly. What typically emerges—and has over these several weeks of low volatility and strong stock growth—is the “buy the dip” mentality that can grip the stock market no matter what the headlines and earnings announcements say. The slowing global economy and low inflation had little negative effect as investors poured into riskier assets, including stocks.
As a long-time option market maker in a past career and now an option strategist for clients, I’ve seen this movie a time or two. Selling puts, or taking bullish positions, becomes the norm. Proponents point out that this tack works out, over and over again … until it doesn’t. The reality of the bull market is, yes, a reality that has colored the last few years, but stocks may be running into some near-term resistance.
For starters, we’re in uncharted territory as far as central bank policy is concerned. Interest rates remain at low levels as the U.S. dollar rises. In fact, interest rates remain at the “crisis levels” put in place in response to a global recession, but jobs data and consumer sentiment continue to improve.
When interest rates have risen in the past, we have historically seen stocks go higher. But that’s history. Is this time going to be different? Economic data theoretically supported a Fed hike more than a few times over the last year, but now the Fed may be behind the curve. One thing we stress with our RED Option strategies is to reduce risk when we can and not when we have to.
Bottom line: Although volatility remains low and investors’ penchant to “buy the dips” has been a supporting floor in the stock market’s recent run, traders and investors may be wise to recognize that option premium is low and a degree of risk protection, often via the option market, may be worth a look.
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