Inside Volatility Trading: The Rally We Love to Hate

Kevin Davitt
June 16, 2020

On a recent Microsoft Teams call with my work teammates, I inquired about everyone’s weekend. The ask was not superficial, because I was curious to know if everyone ventured out as much as I had.

Until most recently when some states began easing their Stay-at-Home orders, it had become increasingly difficult to recall the days of the week by name. At times it felt as if days bled into weeks and months. That can happen when a global pandemic confines you to your house and general vicinity for months, but I digress.

During our call, you could hear each person light up as they dazzled with individual tales of al fresco dining, consummated hair salon appointments, walks along the Jersey shore, car engine work, farmer’s market jaunts, socially distant fire pit gatherings and Flex-Seal…it made sense in context! There was even a teammate who expressed borderline embarrassment about wearing a mask in a small boutique while most people bare-faced.

It is only natural after 10 weeks of confinement to find the general public wants to return to a normal life of engagement with others. It’s inevitable.

Imagining our team is reflective of the world at large; people that long for a return to everyday life. Is it so surprising that the stock market wants to return to a level of normalcy?

After it bottomed on March 23, the S&P 500 Index shot up 40% in 50 trading days by June 3—the highest return over so short a period since 1933, according to S&P Dow Jones Indices. Then investors waited with bated breath for the May nonfarm payroll report. The consensus was that it would show 19.1% of the American workforce was unemployed. However, something unexpected happened on the way to the release. Apparently, the labor market snapped back to life.

Source: U.S. Bureau of Labor Statistics

After two months of carnage, employers added 2.5 million jobs last month, the most in a single month on record dating back to 1948. The headline jobless rate fell to 13.3% from April’s 14.4%, a post-World War II high. This report beat the odds of more expected bad news. Additionally, it gave stocks the all-clear signal for launch as the S&P 500® rose as much as 3% on June 5. Only six days after Bob Behnken and Doug Hurley made history with a much more meaningful launch in SpaceX Crew Dragon.

Friday June 5 was historic for a different reason. There were 29.2 million U.S. listed call options to hit the tape that day. That is a new all-time daily record.

By market close on Monday, June 8, we had done it. The S&P finished up 1.2% on the day, it’s seventh positive day in a row, but more importantly with a closing price of 3232.93 we were positive for 2020—Mission Accomplished.

Source: Cboe LiveVol Pro

Short term volatility (10- and 20-day) had declined to the lowest levels since February 21. The VIX® Index had an intraday reading below 25 for the third day in a row. The previous day’s close was 24.52, which was the lowest closing reading since February (also on the 21st).

The VIX Index closing high during the pandemic was 82.69 and occurred on March 16. However, peak-panic arguably happened on March 23 when the S&P 500 Index had an intraday low of 2191.86. From that day to June 8, the VIX Index had now declined 58% to a close of 25.81 and there was no panic in sight.

Source: Cboe Global Markets

The VIX term structure was a far cry from the backwardation seen in March (blue). However, it was not quite game-on for selling volatility yet. All monthly expirations still remained above 26, which relative to historical levels, is unusual and the front part of the curve was relatively flat. However, it didn’t matter.

Optimism had become the sentiment of the day. The markets were even optimistic in the face of nationwide protests and civil unrest the likes of which has not been seen since the Vietnam War era. At its core, the ideology of the protests is overwhelmingly just—the preservation of life.

Back to the markets, candidly speaking, they were on the precipice of euphoria. The Fear Of Missing Out (FOMO) was showing up in the most embattled industries of the year. Airlines, hotels, cruise stocks, retail and restaurants. It was also rearing its head in the most unlikely of places.

It is widely speculated that the pandemic will cause a surge in bankruptcies although they are only beginning to show in the data. Hertz Global (HTZ), J.C. Penney (JCP), Whiting Petroleum (WLL), and Neiman Marcus were among the 28 companies that sought bankruptcy protection in May, bringing the total this year to 99 and putting 2020 on pace to top the 2008 level.

On June 8, jubilant traders feeling that some stocks had rebounded out of reach began to scour for alpha in the form of stocks of companies that have filed Chapter 11. The price appreciation for many of these issues defied logic with several companies doubling in the trading session. Want examples?

Chesapeake Energy Corp, which is preparing a bankruptcy filing, saw shares rise 182% in one day. GNC Holdings, Inc (GNC), which is in the middle of negotiating a bankruptcy loan, saw shares appreciate 106% in a single day. The excitement was on full display.

And that type of excitement can arguably be dangerous.

However, it had become clear investors were willing to buy at all costs. What exactly had emboldened investors to be so bullish about this market in the face of a 40+ percent rally? It’s simple. Two words.

The Fed.

The Federal Reserve bank has endless capacity and vast willingness to turn any bad news into good news by buying securities. Mohamed El-Erian, chief economic adviser at Allianz recently said it best. “In the equity market, there’s nothing more comforting than the notion that someone with a printing press in a basement and an unlimited ability and willingness to buy is your backstop.”

By Tuesday, June 9 it was confirmed that the U.S. is officially in a recession. The market was unfazed, and instead looked ahead to the Federal Open Market Committee meeting that most likely would wrap-up the very next day with the benchmark overnight rate remaining in a target range of zero to 0.25%. A level that it has been at since March. Could it be possible for the Fed to undo the very optimism that the Fed itself has helped create? In a word – Yes

At the conclusion of the two-day meeting, Federal Reserve Chairman Jerome Powell sent a powerful message that the central bank will keep pumping stimulus into the U.S. economy until the shattered labor market has healed from the pandemic. As predicted, the key interest rate will remain near zero, from now through 2022. However, it was the Fed’s dovish tone that clouded hopes for a speedy economic recovery. In effect, it was a cold shower on the recent optimism.

Stock indexes took a small hit on the day of the meeting, but by the morning of Thursday, June 11, the rhetoric from the Fed meeting coupled with fears of a second wave of the pandemic and initial jobless claims remaining in the millions sent the S&P 500 into a tailspin.

Source: Bloomberg

The S&P dropped almost 6% and came close to the 7% threshold that would have triggered an exchange-mandated trading pause. The very same airlines, cruise stocks, hotels, retails and restaurants that had been recently soaring were among the hardest hit.

It’s as if we just experienced three trading regimes all in the course of one week. Optimism (prior to June 4), euphoria (June 5-9) and fear (June 10-11). The VIX Index rose 48% on the day, which was the 7th largest 1-day% increase in history. Two of the top 10 have happened in this year with the other occurring on February 24 when the VIX Index climbed 46.5%, which was at the beginning of the pandemic. Is this the beginning of a new volatility regime? Hard to say. What’s not hard to say is this year will be memorable.

Source: Trade Alert, LLC - A Cboe Global Markets Company

“2020 will go down in history for many reasons, including listed option volume that topped 47.1M contacts on June 11, which was the sixth day over 40M this year and second only to the 47.3M traded on Feb 28th,” said Henry Schwartz, senior director and head of Product Intelligence. Mr. Schwartz is one of the newest members of the Cboe team and came on board with the exchange’s acquisition of Trade Alert, LLC, a real-time alerts and order flow analysis service provider.

The option flow from June 11 involved 5.9M individual executions, which was a new record. Year-to-date volume has surpassed 3 billion contracts and is on track for 6.8 billion for the year, which would be 33% above record-high achieved in 2018.

Was the selling due to a misplaced, overly optimistic view of the market? Did the Fed’s comments leave a sour taste in the mouths of investors? Did investors finally decide millions unemployed and negative GDP are too much to handle? It doesn’t matter.

We all know this is The Rally We Love to Hate.



People may not be particularly drawn to the most recent equity market rally, but there is a very real appeal to “the exotic.” Novelty has an inherent allure. To paraphrase Paul Simon, a couple months back the largely locked down nation turned their lonely eyes to Netflix and specifically, Joe Exotic. During the first 10 days that Tiger King was available for streaming, roughly 35 million unique viewers followed the story of Joseph Allen Maldonado-Passage.

Exotic options may not garner the same level of attention, but they are worth understanding. In our previous Inside Volatility we highlighted the utility and growth in FLEX® options. In short, they are fully customizable, non-standard options and volume growth has been tremendous.

FLEX options may take the form of one of several exotic options. Did you know there are Look-Back Options, Bermuda Options, Barrier Options (Knock In/Out), Range Options, Basket Options, Asian Options, Cliquet Options and many other non-standard options?

FLEX options as well as Exotics offer end users the ability to solve for particular risks that ordinary options may not. They are similar in most ways to standard listed products, but have small tweaks in their construction that must be understood.

Asian options are based on the average price over a specific period of time whereas standard options price based on the prevailing spot market value for the underlying. As our quantitative readers know, there are a few ways that the term “average” can be construed (arithmetic mean v. geometric mean). Consequently, the calculation is laid out in the terms of the contract.

Payoff profiles for Asian options are path dependent. Lookback and Barrier options also have path dependent payouts. Theoretical pricing for Exotic options are more difficult. Asian options will (almost always) have lower premiums than standard options, which is appealing to a number of market participants with specific risk profiles.

For example, someone who’s concerned with potential fluctuations in interest rates over a specific time frame may be inclined to solicit an Asian style option to mitigate some of their exposure.

Asian options could also be appealing when an underlying security is fairly illiquid and there’s the potential for big single-session volatility.

Get the Inside Volatility Trading newsletter directly in your inbox by signing up here.