Cboe Global Markets

Inside Volatility Trading: Back Again So Soon?

Kevin Davitt
June 30, 2020

An early look at players in uniforms is an annual marketing ploy by the National Football League. Recently, marquee quarterback Tom Brady unveiled his new look with the Tampa Bay Buccaneers after twenty years of service for the New England Patriots.

Source: National Football League

The eventual hall of famer drew an equal amount of cheers and jeers from football fans. One fan, a well-known supermodel, shared her supportive reaction to the new uniform on social media by writing “What a cutie.” Of course, that supermodel is his wife, Gisele Bundchen.

It is unclear if or when football players will once again toss around the pigskin, nevertheless, the National Football League continues to make plans for the 2020 season. Major League Baseball (MLB) and the National Basketball Association (NBA) are also making plans, which currently slate them for a late July start in fan-less stadiums. Imagine only hearing the crack of a bat as it hits a 95 MPH fast ball. Or hearing only the smack of two hands clasping a rebound from a missed shot bouncing off the rim. Strange.

After the Federal Reserve decreed it would expand its purchases of corporate bonds, stocks rebounded 1% for the week ending June 19. Retail sales deserve some of the credit as the 17.7% rise in May over April was a breath of fresh air for the markets.

The 5.9% S&P 500® decline on June 11 caused the Cboe Volatility Index® (the VIX® index) to close above 40 for the first time since April 23. Unsurprisingly, that move also led to a 125% jump in 10-day SPX® realized volatility from the mid-teens to the mid-thirties; levels also not seen since April. That said, as June expiration approached, we enjoyed a relatively quiet week as investor confidence was slowly recovering. By June 18, although the VIX Index declined 19% in a week, it could still be considered elevated with a reading of 32, which equates to 2% daily moves.

Some expirations tend to come and go without much fanfare, but this one had the potential to be different. Volume was expected to be robust due to quadruple witching; the expiration of options and futures on indexes and equities. Almost $2 trillion notional of June SPX options was expiring. That is the third-largest, non-December expiration on record according to data compiled by Goldman Sachs Group Inc. All it takes is the appropriate market moving headline to cause a trader’s portfolio gamma to completely change.

Source: Wall Street Journal, Bloomberg and BBC News

Suffice it to say, there were plenty of headlines, but none seemed to strike the right chord. Former national security adviser John Bolton unveiled a new book with interesting details about President Trump and the U.S.-China relations during his tenure. North Korea blew up an inter-Korean liaison office. Beijing saw a fresh outbreak of the virus but in limited numbers. However, none of them moved the needle.

Along the way, there was a quiet chorus that began to get louder each day as we got closer to expiration. Virus cases were rising in Texas, Florida and California. By Friday June 19, Texas saw hospitalizations climb for a record seventh straight day, Florida cases rose the most ever and California had the biggest one-day jump in coronavirus infections. In the wake of this news, Apple, Inc (AAPL) decided to close doors at 11 stores across Florida, Arizona and North and South Carolina.

Source: Bloomberg

Finally, a headline that mattered to markets. There’s been talk about a second wave for months, but most expected a resurgence (if any) to come in the fall. As least that’s what history has led us to believe. The Spanish Flu of 1918 saw a significant number of lives extinguished during its second wave in the fall of that year.

Regardless of what we thought, the chorus became too loud to ignore. Expiration Friday was a somewhat volatile trading session. The SPX initially rose 1.2% on news of China’s plan to accelerate purchases of American farm goods to comply with phase one of the trade deal. However, by the end of the day the broad-based index reversed to fall 0.6%; overall a 72-handle range on the day.

The exuberance that marked the beginning of the month seems to be hanging on by a thread. The market is fragile right now. Want proof?

Source: Bloomberg

On Monday June 23, White House adviser Peter Navarro—a known “China hawk”—implied the U.S.-China trade agreement was “over,” and blamed the breakdown of the deal on China not promptly alerting the U.S. about the spreading of coronavirus after the phase one accord signed on Jan. 15. Markets were closed, but S&P 500 futures fell as much as 1.6% to 3060 while July VIX futures rose as much as 8.6% to 34.35. Both recovered after Navarro told the media that his statement was taken “wildly out of context.” Phew.

However, it was another clear sign that investors are concerned and it’s showing up in all the usual tells. As the chart below shows, the S&P 500 Index is close to the same levels it was prior to the pandemic but this time the VIX Index is higher. It’s tough for derivative markets to hide the worry.

Source: Cboe Global Markets

It’s almost as if investors are beginning to acknowledge that the recovery might take longer than anticipated. Even Jim Cramer is talking about the idea of taking some risk off the table.

Last week, Cruise line companies Royal Caribbean (RCL), Carnival Corporation (CCL) and Norwegian Cruise Line Holdings (NCLH) took a hit as the Cruise Lines International Association (CLIA) announced it would suspend ships sailing from US ports until September. Not surprising, yet it dampens the hopes of those looking for a return to normal.

Disney (DIS) is delaying the phased reopening of its flagship theme parks in California. Originally slated for a July 17 reopen, the resurgence of virus cases has pushed it back to an uncertain future.

The Pro Football Hall of Fame canceled the NFL’s preseason-opening game between the Dallas Cowboys and Pittsburgh Steelers and postponed its annual enshrinement ceremony. The game was scheduled to play on August 6 in Canton, Ohio, but has been rescheduled for 2021.

What’s next? Cancel Christmas? I guess we’ve got some time before that arguably apocalyptic event.

If you’re wondering when it will all be over, consider this: Cantor Fitzgerald strategist Eric Johnston outlined in a June 18 his prediction for equity volatility:

“Given continued uncertainties as the economy reopens, an upcoming election, along with the daily bid for volatility ahead of case data on select U.S. states, we don’t foresee a VIX Index below 20 until an approved vaccine for Covid is achieved.”

The next question, naturally, is “when will there be a vaccine for COVID-19?” According to Dr. Anthony Fauci’s recent testimony on Capitol Hill, he’s cautiously optimistic there will be a vaccine by the end of the year or early 2021.

On second thought, maybe we will cancel Christmas.

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