In like a Lion….or Bulls on Parade
In the late 1960s John Fogerty (Creedence Clearwater Revival) wrote Proud Mary which could well describe the broad market of late.
Big wheel keep on turnin’
Proud Mary keep on burnin’
Rollin’, rollin’, rollin’ on the river
As we roll toward the end of February and into March, equity markets have been on a tear. The S&P 500® Index keeps on turnin’, burnin’, and rollin’.
March tends to act as a bridge between winter and spring. In the northern hemisphere we can see snowstorms and 70 degree temperatures in a matter of days. There’s a tendency for the month to begin cold and foreboding, but often end with much milder weather. Hence the idiom, March comes in like a lion and out like a lamb.
Prior to the significant decline between February 20 – 25, US equity markets had been climbing quite steadily. This is a very real example of how rapidly markets can reprice risk. Spasmodic risk, like the current period, has become more frequent in recent years (Aug 2015/Feb & Oct 2018/Feb 2020). In those instances, volatility was a potential source of future returns. In this case, it remains to be seen whether the pullback will be more meaningful.
The S&P 500® settled at 3225.52 at the end of January and moved up to 3392.52 on February 19 -- a 5.2% rally in less than three weeks. If we look back to early December of last year (SPX℠ 3070) the market has advanced by 10.5% over the previous 10 weeks.
This is arguably reminiscent of the late 2017/early 2018 period, which included a 7.5% jump between January 1 and 26. Between the middle of November (2017) and the eventual highs of January 26, 2018, the S&P 500 rallied 12%.
On November 24, 2017 the VIX® Index made an intraday all-time low with an 8.56 reading. Interestingly, during January of 2018, the VIX® Index moved slightly higher despite the broad market’s advance.
Until the past few trading sessions, during which there’s been a tremendous shift in sentiment, the market had weathered the perceived economic risks associated with coronavirus (COVID-19) despite its continued spread and mounting death toll. In fact, by one option-based metric, investors’ sentiment may be as bullish as it’s been in decades. According to a Bloomberg article, option traders purchased 24 million calls during the week ending February 14. That figure is historically unprecedented. 
The difference between call options bought to open and calls sold to close was more than 14 million. In general, far more calls are bought (opening) versus those sold (closing). However, there have been a handful of occasions where that weekly imbalance has been greater than 10 million.
The aggregate call buyers have laid out roughly $16 billion in premium between February 3 and 14. Jason Goepfert draws some analogies to the late 1990s but admits the period was an “extreme case.” You could argue that the primary “fear” in the market at this moment is the “fear of missing out.”
The previous instances where there were very large spreads between call buyers and sellers were in early 2010, prior to the “Flash Crash.” It happened again late in 2010 as well as toward the end of 2017/early 2018. According to their research, during the four instances over the past 20 years, “stocks fell a median 4% two months later.”
This is by no means intended to be inflammatory. These are data points. It’s a perfect illustration of volatility being non-directional. Most people associate the term with downside risk, which makes sense given most investors are concerned about moves lower (not higher). However, upside volatility is real and the past few weeks are illustrative. The vast majority of Cboe’s Volatility Indexes have moved higher in the last month.
Source: Cboe Global Markets and Bloomberg (as of 2/21/2020)
Readers have indicated an appreciation for merging of history, sports, music, and volatility. As such, here’s a few historical nuggets from past February 25ths.
- 1804: Thomas Jefferson (incumbent) nominated for President by the Democratic - Republican Party. He ultimately defeated Charles Pinckney (Federalist) of South Carolina
- 1862: First Legal Tender Act approved in Congress which authorized the US Note (“Greenback”) into circulation. It was the first legal “fiat” money in the US.
- 1901: JP Morgan organizes US Steel Corporation
- 1963: The Beatles release “Please Please Me” in the US (1st single)
- 1969: The Beatles begin recording Abbey Road (last album)
And In the End
Both realized and forward-looking volatility has picked up in the short term. It remains to be seen whether the “bulls on parade” who recently gorged themselves on a call heavy diet will be rewarded or remorseful.
With Valentine’s Day behind us, the NCAA Tournament (go Marquette) and MLB’s Opening Day ahead, we’ll conclude with a succinct reminder from Paul McCartney that all runs come to an end.
And in the end
The love you take
Is equal to the love you make
To learn more about index options and the volatility markets or network with others that operate in the space, join us at Cboe's 36th Annual Risk Management Conference (RMC) in Bonita Springs, Florida starting March 2nd.
[1.] The piece references Options Clearing Corp. (OCC) data tracked by SentimenTrader.
Video: Broad Market Slide Continues
Welcome to our new section. Every Inside Volatility update will feature a question from one of our readers. Curious about a topic? Send an Email to [email protected]
Q: What exactly is forward vol? (New York, NY)
There were more than a few questions about the SPX℠ forward volatility chart in the last Inside Volatility newsletter.
A: All options prices are informed by an assumption about future volatility (IV) which can be backed out using an options pricing model. Options with different maturities (expiries) usually have different implied volatilities. This concept speaks to the term structure of volatility and applies to all products.
Forward volatility calculates the amount of volatility that would need to be realized between two different maturities in order to explain the current implied volatility estimate. Understanding the concept is critical, but like most other quantitative endeavors, after you comprehend the theory, the execution is often best left to Excel. 
An oversimplified example may illustrate the concept.
Imagine a college student has a 3.6 GPA after their junior year of college. This college runs on semesters, so 6 terms have been completed.
If that student forecast a GPA of 3.7 at graduation (8 terms) what GPA would they need to realize in their final 2 semesters to realize the 3.7 forecast?
Quick and dirty math:
- 3.6 * 6 = 21.6
- 3.7 (FUTURE TARGET) * 8 = 29.6
- 29.6 – 21.6 = 8.0 (which is divided by 2 because there are 2 semesters, or terms, remaining).
This student would need to “realize” a 4.0 in each of their final terms to “explain/justify” a 3.7 (future goal).
What if the student earned a 2.5 GPA in their final 2 terms? What would that do to their cumulative GPA?
- 3.6 * 6 = 21.6
- 2.5 * 2 = 5.0
- 21.6 + 5.0 = 3.325
So, if “Senioritis” afflicts our hypothetical student and they earned a 2.5 GPA (average) in their final 2 terms, their cumulative GPA would fall to 3.325.
 Forward Implied Volatility in Excel
Cboe Will Be Attending:
March 10, Capstone Global Volatility Summit in New York, NY
March 10-12, FIA Boca in Boca Raton, FL
March 21, TD Ameritrade Market Drive Event 2 in Anaheim, CA