Powell & Trump Stir the Winds of Change
“The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.”
—William Arthur Ward
The previous two Inside Volatility Newsletters shone a light on relatively low levels of implied volatility for 1-month VIX options as well as muted historical volatility for the S&P 500® Index (SPX). The confluence of these types of vol events could portend a potential shift in sentiment. At the very least, the options market was pricing in a fairly unusual level of complacency.
In the ensuing weeks, the VVIX Index (VVIX), which measures the expected volatility of the 30-day forward price of the VIX Index based on VIX options, moved from 75.37 to 111.33. VVIX generally ranges between 85 and 110. In short, the cost of 1-month VIX options moved from historically very low levels to the high end of normal. During the October 2018 SPX sell-off, the VVIX measured above 145 intraday. At current levels (as of 8/2/2019 10 a.m. CST), VVIX is running at the high closes from May 7, 2019 and December 24, 2018.
Over the same time frame, 10- and 30-day historical volatility on the SPX have moved from 6% and 7.4% to 11.63% and 9.23%, respectively.
Since making new all-time highs on Friday, July 26 (3027.98), the SPX declined by more than 110 points, or 3.76%. Last week, the equity, volatility and bond markets all moved with meaningful velocity on the heels of the first rate cut in the U.S. since December 2008, as well as a threat from the Trump administration to enact further tariffs on $300 billion worth of Chinese goods.
On July 31, Robert Lighthizer (trade negotiator) and Treasury Secretary Mnuchin concluded another round of talks with China, with apparently little progress. The diplomatic euphemism for the meeting was “constructive.” The following day (August 1), President Trump agitated capital markets with the potential imposition of further tariffs on September 1.
Cboe calculates volatility indexes for broad-based U.S. equity indexes, international ETFs, interest rates, commodity ETFs, currencies, single stocks, as well as the VVIX. All 30 volatility indexes closed higher on August 1.
The VIX Index, as well as the associated futures, tend to have a negative correlation to the S&P 500. Market participants may look to insulate themselves against macro downside risk with either SPX puts or potentially VIX calls. On a typical trading day, about 1.7 SPX puts trade for every 1 SPX call. In the VIX derivatives complex, the options trading is call skewed, with about 2.1 VIX calls trading for every 1 VIX put.
There was some interesting options activity in VIX options ahead of the Federal Reserve Meeting that ostensibly capitalized on the relatively low levels of VVIX. Between July 23 and July 30, more than 1.22 million out-of-the-money August and September VIX call options were purchased (buy-to-open). The total premium outlay was roughly $57.3 million.
To illustrate just how active VIX calls were relative to puts, below is a breakdown of the highest VIX call/put ratio sessions going back to January 2008.
Source: Cboe Exchange, Inc.
On July 29, more than 11 VIX calls traded for every 1 VIX put. That was the most call-skewed activity in nearly four years. For some context on the other dates:
- 6/27/2011: Escalating European sovereign debt crisis. Shortly before establishment (7/11/2011) of the European Financial Stability Facility, a bailout fund that would lend up to 500 billion euros.
- 8/10/2015: The VIX Index ~12.25 with SPX just off all-time highs. Between Aug. 17 and Aug. 25, the S&P 500 declined by more than 11% on Chinese devaluation and the “ETF flash crash.”
- June and August 2014: Preceded escalating concerns about global growth as well as the Ebola scare.
It remains to be seen whether the more recent call-heavy VIX options activity has been monetized. Open interest (OI) in the August 18/20/25/30 calls have remained fairly steady. So too has the OI on the September 23/24/25 calls. One thing seems clearer: The options markets are pricing in significantly more uncertainty than they were just a week ago.
A sincere thank you to Brandt Lawson who has been a tremendous help to the Options Institute and Global Benchmark Index Advancement teams.
Seeking Alpha: VXX: Short the Rally in VIX
Bloomberg: Gold Traders Get Little Rest from `Wild Day’ as Volatility Jumps
CNBC: Traders are Betting Big on a Sudden Drop in Stocks and it's starting to Pay Off
MarketWatch: VIX Stock-market Volatility Gauge at nearly 2-month High as Trump Plans New China Tariffs
CNBC: Powell is 'Confusing' the Markets about Fed Intentions, but a New Cut is expected
S&P Dow Jones Indices Indexology Blog: Cboe S&P 500 Buffer Protect Indexes: First Outcome Period Recap