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Volatility Update: Tales of a Mixed Tape and Dropping Correlations

August 4, 2016
Volatility index shows fluctuating stock market financials.

The S&P 500 recorded gains in July and finished the month setting record highs. The rally in the last two weeks of the month was slow and methodical. A slow grind higher, if you will. And this underlying sentiment seems much different than a month ago when stocks fell, then rebounded sharply, amid unexpected political headlines from across the Atlantic in the form of Brexit. Indeed, many measures of market volatility moved sharply lower during July and, by at least one measure, correlations fell to new lows for the year.

Volatility Comes Under Pressure

CBOE Volatility Index (VIX) finished July near 12 and probing the lower end of this year’s range. In doing so, the index, which tracks the expected or implied volatility priced into a strip of short-term S&P 500 Index (SPX) options, shed 22% for the month and lost more than half its value since the spike to multi-month highs in late-June. The Daily chart in figure 1 shows the dramatic slide in the market’s so-called “fear gauge” during July.


VIX finished July near 12 and at the lower-end of the 2016 range. Data source: CBOE. Chart source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Several factors seem to play important roles in lessening market volatility last month. Worries about the UK referendum to leave the European Union have receded and the result has been far less turbulent market action across Europe’s stock markets. Meanwhile, the SPX rebounded sharply from the late-June lows and tallied a 3.7% gain for July. Through the end of last week, the SPX is now up 6.4%.

Looking at the performance of various sectors in the table below, seven of ten scored gains last month. Technology was leading the pack, but Basic Materials, Healthcare, and Consumer Cyclicals outperformed as well. Notable laggards included Energy and Consumer Staples. Still, nearly every market sector, with the exception of Financials, is now positive for 2016.

Health Care4.8%4.3%
Consumer Disc.4.4%4.3%
Consumer Staples-0.9%8.2%
S&P 5003.6%6.4%

Source: Frederic Ruffy. Data through 07/29.

From Macro Volatility to Micro Correlations

Another development worth noting is the recent decline in correlations among individual equities. While most sectors of the market moved higher last month, not every sector participated equally in the advance as we just discussed. In addition, as focus seemed to shift away from events overseas and to the now unfolding Q2 earnings season, stocks started trading in increasingly mixed fashion.

That is, there was less co-movement among individual stocks within the SPX and the shifting pattern is reflected in a sharp drop in the CBOE Correlation Index (JCJ). Created by the CBOE, the JCJ measures how various stocks are trading relative to each other. Increasing JCJ indicates greater co-movement and vice versa.


Correlations, as measured by the CBOE’s JCJ Index fell sharply in the first half of July. Data source: CBOE. Chart source: the TD Ameritrade thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Correlations and market volatility often go hand-in-hand. In July, as VIX fell towards 12, JCJ was trading below 50 and well below the mid-60s seen in late-June. The JCJ even fell to 52-week lows of 45.97 mid-month. These low readings suggest less co-movement (more mixed trading) and a pattern that stands in stark contrast to the setting a little more than a month ago. While it seems to have resulted in smaller trading ranges for some measures of the broader market, such as the SPX, it’s also a reminder of just how rapidly market volatility can come and go in today’s fast moving financial markets.

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RED Option Strategy of the Week: Double Calendars

T.J. Neil, Sr. Specialist, RED Option

Editor's Note: As of October 3, 2016, RED Option is now TradeWise.

Earnings season is in full swing, but broad market volatilities have remained low.  Last week, I discussed using an iron condor to trade earnings in individual stocks. This week, I’ll discuss a strategy designed to trade the low volatility environment. This strategy is a double-calendar and it’s designed for a lower-volatility environment with range-bound price action. 

The double calendar is a multi-legged option strategy. It's a range-based trade that has a wider breakeven range and a greater probability of success than an individual calendar spread. But the tradeoff for a greater probability of success can be a lower potential profit. 

In a previous article, I discussed long calendar spreads. If you happened to miss that piece, here’s a quick overview to get you up to speed. 

Calendar or time spreads involve buying an option in one expiration cycle and selling another option in a different expiration cycle, but with the same strike, with the options being both calls or both puts. Long calendars involve purchasing the further-term option and selling the near-term option so that the position remains risk-defined. The strategy seeks to take advantage of the underlying trading at or near the strike price, with the highest potential for profit occurring in a rising volatility environment. 

The double calendar is a combination of two calendar spreads. One call calendar spread and one put calendar spread. Traders typically buy an out-of-the-money call calendar and put calendar around the current underlying price. The result is a trade that’s range-based, like the neutral single calendar. But instead of having a profit peak at just one strike price, the double calendar has the potential for profit over a wider range of prices. Similar to the single calendar, the double calendar is designed to benefit from an increase in implied volatility (IV). A double calendar has two peaks or price points where the largest gains can be achieved. This max gain potential can change based on changes in IV. 

The risk involved in the long double calendar spread is limited to the amount paid to place the trade, including any transaction costs. With a long double calendar, traders typically want to adjust or close the trade for a credit, and the ideal scenario is for the underlying to move toward either strike. Although an increase in volatility would work best for the strategy as it moves close to either strike in the position, time decay, or theta, also works in favor of the trade. This occurs because the short near-term options tend to lose value faster than the further-term long options in the trade. 

Another potential benefit for long calendar trades is that although the initial risk is defined, the profit potential can increase as volatility rises. This is one reason initiating long calendars in a low-volatility environment can be beneficial. 

The double calendar spread to play a stock with an upcoming earnings report seeks to take advantage of elevated volatility levels in the shorter term options you’ll be selling, and the normalized volatility levels in the farther term options you’ll be purchasing.  Of course, it’s impossible to tell the future, but if you are able to judge the range of the stock’s earnings move correctly, you can set your strike prices to position your trade for the best possible outcome based on your assumptions. 

In conclusion, if you have a feel for a stock’s earnings move, and volatility is low, a double calendar may be a strategy worth considering, as it gives you a wide range and a risk-defined downside.

Please remember that calendar, double calendar, and other multiple-leg option strategies like these can entail substantial transaction costs, including multiple commissions, which may impact any potential return. These are advanced option strategies and often involve greater risk, and more complex risk, than basic options trades.

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