The S&P 500 (SPX) fell to its lowest levels in more than a year in the middle of last week before a recovery salvaged the first weekly winner so far in 2016 for this broad stock average.
The whipsaw action appeared to stir investor anxiety levels. As evidence, the CBOE Volatility Index (VIX) jumped above 32, its highest level since early September. But it’s not just VIX that’s moving higher; other important volatility barometers were up as well. That’s right, volatility is spread across a variety of stocks, emerging markets, oil, and more. Historical volatility was elevated, too. That means “real” volatility has flared alongside “anticipated” volatility.
For sure, VIX has been on a tear in the past few weeks. Sometimes called the market’s “fear gauge,” VIX tracks the implied volatility priced into short-term SPX options (figure 1).
Few Markets Untouched
Here’s a scan of volatility in the many hovels of global markets (see table below). While VIX gained 51.5% so far in 2016 through last Thursday, the CBOE NASDAQ 100 Volatility Index (VXN) and CBOE DJIA Volatility (VXD) rose more than 55%. Large volatility moves were logged in crude oil, emerging markets, and more.
|S&P 500 Volatility ||VIX||51.5% |
|NASDAQ 100 Volatility ||VXN ||57.1% |
|Dow Volatility ||VXD ||58.6% |
|Russell Small-Cap Volatility ||RVX ||46.5% |
|Oil Volatility ||OVX ||45.9% |
|Gold Volatility ||GVZ ||10.5% |
|Emerging Markets Volatility ||VXEEM ||58.9% |
|Brazil Volatility ||VXEWZ ||16.7% |
|Euro Currency Volatility ||EVZ ||3.2% |
|China Volatility ||VXFXI ||60.5% |
(Source: CBOE. YTD through Wednesday, January 20, 2016)
VIX, VXN, and other indicators in the table above are all measures of volatility that are derived from options premiums and computed using option pricing models. These indicators can sometimes help traders get a better sense of the actual volatility of the underlying security, but they also reflect expectations about the future “implied” by option prices.
But the recent uptick in volatility is not just because of an increase in risk perceptions or expectations about the future. The actual volatility of the market is quite high historically as well. Consider this: the average daily move in the S&P 500 during 2015 was about 14 points. So far in January, the average daily move is 25 points. Not only has the equity market been trending lower, but it’s also moving in larger daily strides.
In other words, the market’s actual volatility is moving higher, and that’s confirmed by the daily chart of the S&P 500 (see figure 2). The graph shows that the 20-day historical volatility (HV) of the index is moving above 20% for the first time since October. While VIX is based on options premiums, HV is computed using the actual closing prices of the index over a number of days. The 20-day historical volatility had fallen toward 10% in November. It has nearly doubled since then.
VIX tends to react to equities market swings from periods of low to high volatility, but VIX is also driven by sentiment. Remember, it reflects expectations about the future. Historical volatility measures how the underlying security is actually behaving. In this case, real volatility on the S&P 500 has been climbing steadily higher since November. Connecting a few dots would suggest that the market is making larger daily moves, not just on days when SPX is lower, but when it is moving higher as well.
Tom White’s RED Option Commentary: Earnings in Full Force
Editor's Note: As of October 3, 2016, RED Option is now TradeWise.
One-third of the S&P 500 companies report earnings this week, including typically high-volume option movers Apple (AAPL), Amazon (AMZN), and Facebook (FB). Earnings growth forecasts are supposed to slip by almost 6% this reporting quarter, which would be the second straight quarterly profit decline in a row, say industry analysts. Revenue across SPX companies is expected to notch a fourth straight quarter of declines, which would be the most in a row since the 2009 recession. Earnings roll in against one of the worst starts to a year in the stock market’s history, approaching correction territory. VIX has closed above 20 in each day but one so far this year and options trading logs reveal some traders are reaching for short-term market protection.
What’s more, multi-year lows in the price of oil (/CL), slowing global economic growth, and the strong dollar are weighing on corporate results. While the added volatility and falling equity market can create anxiety, earnings season can provide ample opportunities to trade options. New positions, hedged trades, and some degree of short-term protection are some of the ways that some options traders use the options markets; notably, the increased uncertainty and corporate news can increase option premium.
At RED Option, we trade earnings in many companies, but we aim to do it in a risk-defined way. When we initiate a new position, we know exactly what our potential downside is on any trade. For instance, we do not sell naked calls or naked puts, due to the undefined risks involved in the trades. We buy or sell vertical spreads, sell iron condors, and more. All trades have probabilities in our favor and are risk-defined. When adjusting or managing a position, we never increase the risk in the original trade. We use our guidelines to provide opportunities to take positions using options, while staying conservative with the trades.
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