Cboe Global Markets

Inside Volatility Trading: Forgetful Volatility Measures

Kevin Davitt
April 6, 2021

How time has revealed

How little we know us

I’ve been too busy

I should have noticed

Angel Olsen - Spring

Are We There Yet?

April 6, 1909: Robert Peary, Matthew Henson and four Inuit believed they were the first explorers to reach the North Pole. The veracity of the claim has been contested, but there’s no doubt the group got close to 90.00° N, 135.00° W. 

Peary was an engineer and a military man. He had been exploring previously unknown portions of Greenland and the Artic for decades. Henson, who had accompanied Peary on several journeys, returned to say, “I think I’m the first man to sit on top of the world.”

The story strikes me as somewhat analogous to capital markets. There are “tops,” but nobody knows for certain if and when they are reached. The S&P 500 and VIX® Indices have been traversing new ground of late. The large-cap bellwether (S&P 500 Index) has been grinding in its ascent toward the 4,000 level. Conversely, the VIX Index has been plumbing below the 20 line, which has been unexplored territory in the post-pandemic world. The small-cap Russell 2000 (RUT®) Index, which has experienced a historic run over the past six months, has staggered since mid-March. 

Relative March Performance for the S&P 500, Russell 2000 and VIX Indices

Source: Bloomberg

Some Volatility Measures Are Forgetful

Historical volatility measures, by their construction, only recall so much. The S&P 500 12-Month Realized Volatility Index calculation has collapsed over the past month. The data inputs for a one-year historical volatility measure will include 365 days (~252 trading days). As such, March 16 and March 12 of last year have been forgotten by one-year volatility calculations. Those sessions were marked by 11.98% and 9.51% declines in the broad market respectively. The March 24, 2020 session, during which the S&P 500 Index jumped 9.38%, was also recently consigned to the dustbin of (one-year) history. 

Historical Volatility Measures of the S&P 500 12-Month Realized Volatility Index 

Source: S&P Global

Longer-term forward-looking volatility measures, like the back month VIX futures contracts, have been declining with a more tempered velocity. For example, the November VIX futures (VXU21) closed just over 30 in late January during the tempestuous “short squeeze” selloff. That contract remained between 28.70 and 29.50 for the month of February (closing). However, since the March 9 close (28.70), VIX futures with just less than 200 days until expiration have steadily declined and are trading right around 25.

Despite the meaningful decline in forward volatility contracts, the middle and back of the VIX futures term structure remain elevated relative to the typical VIX Index ~20 market that we’ve seen. Jim Carroll of Toroso Advisors notes that “the S&P 500 Index has gained almost 6% year-to-date as 2021 tries to erase memories of last year.” Carroll highlighted the shifting shape of the VIX term structure at three distinct points this year, visible in the chart here. In late January (red line), the curve was backwardated. By early March (blue line), the VIX futures landscape was elevated and flat. More recently (green line), the curve has remained in contango with the VIX Index about 16 points lower when compared to January 27, 2021. The six-month and one-year measures have fallen demonstrably as well. 

Cboe Volatility Index Term Structure

Source: Toroso Advisors

Curious or new to term structure? Check out a brief introduction in Simply Put.

The unparalleled retail interest in (call) options has dwindled over the past six weeks. There have been fewer “meme stocks” making headlines and realized volatility has attenuated, perhaps coinciding with employees returning to work. OCC cleared options volumes are now below recent (all-time) highs. According to Bloomberg, the notional value of the standard March options expiration was the largest ever in terms of single stock exposure rolling off (excluding January which includes LEAPs). Based on recent volume figures, it’s likely that a significant portion of those expiring options were not moved forward. 

OCC Buy Open Premiums Volume Since January 2019

Source: SpotGamma

Spring Ahead?

Looking ahead, April is typically a favorable month for the S&P 500 Index. Over a 56-year time frame, April has the highest average return for the index as well as the largest percentage of positive month-over-month closes. Earnings season will begin in the middle of the month when the big financials report their quarterly numbers. JP Morgan Chase (JPM), BlackRock (BLK), Wells Fargo (WFC), and Goldman Sachs Group (GS) are all expected to announce on Wednesday, April 14. 

Monthly Return Statistics for the S&P 500 Index from 1964-2020

Source: Topdown Charts, Refinitiv

Correlations tend to weaken during earnings season. Stock specific (idiosyncratic) news typically moves some parts of the market higher and others lower. Correlation measures have been declining in advance of Q1 earnings. Cboe’s S&P 500 Implied Correlation Index (ICJ - Jan 2022) is just above the lowest levels in a year. The index closed just over 44 on March 30. The 52-week closing lows occurred in late August 2020 when the ICJ Index measured 41.02. That coincided with a local high for the large cap index (SPX). The S&P 500 Index sold off for much of September last year and correlations strengthened, which is typical during “risk-off” environments.

The ICJ Index made all-time lows in mid-February 2020 at 37.73. A month later, amidst the COVID-19 swoon, correlation measures ripped higher and measured just below 85 on March 19, 2020. It will be interesting to see if the ICJ Index retests the February 2020 lows in the coming weeks.

Risk-On vs. Risk-Off Environments for Cboe’s S&P 500 Implied Correlation Index

Source: Cboe Global Markets

Odds & Ends

The CSI 300 Index is a market cap weighted equity index for the largest stocks traded on the Shanghai and Shenzhen Exchanges. Many consider the CSI 300 Index to be the Chinese equivalent to the S&P 500 Index. It’s been calculated since April 2005, so it turns 16 years old this week.

The CSI 300 Index made highs in early February 2021 and fell 15% from peak-to-trough. The index has regained some footing in recent sessions but remains well off highs from two months ago. Given the interconnected nature of global trade/markets and China’s position as the second largest economy in the world, it’s a trend that bears watching.

The Biden Administration has chosen to maintain the status quo on the tariffs the Trump administration placed on China in 2018, despite the successful Phase 1 trade agreement which was overshadowed by the spread of Covid-19 early last year. Volatility of 10-year treasury yields and the performance of the USD could reignite trade uncertainty as a new negotiation team takes over for future phases.

PhD in Economics?

Copper prices and the Chinese economy have exhibited a strong correlation for years. The massive infrastructure investments in mainland China requires equally enormous amounts of copper to sustain. May Copper futures (HGK21) made 10-year highs in February 2021 around $4.40 per pound. The same contract traded as low as $3.85 in early March. It’s been vacillating on either side of the $4.00 mark of late.

In other words, copper fell about 13% from highs, which mirrors the recent moves in the Chinese equities. The visual below compares the May Copper futures to an ETF (ASHR) designed to track the CSI 300 Index.

May Copper Futures and ASHR ETF CSI 300 Index Tracker

Source: Barchart

Exploring New Areas

The S&P 500 Index is exploring new territories in the “northeast” of charts. The VIX Index coils down to the “southeast.” Longer-term realized volatility measures “forget” the acute risk-off period of early 2020 and market participants recalibrate their exposure into Q2 of 2021. The Ever Given is (finally) dislodged after nearly a week in the Suez Canal, opening one of the most important thoroughfares for global trade.

COVID-19 cases tick slightly higher after declining for months, even as vaccination efforts ramp higher. While the United States is ramping up its vaccination and re-opening efforts, other parts of the world, like the Netherlands and France, are extending restrictions to combat their upticks. Health and economic officials in the United States alike reiterate that recovery is not going to happen overnight, and that while we are on the right path to the “new-normal,” COVID-19 is still a real risk.

The future remains uncertain, but that “wall of worry” isn’t nearly an ominous as it was a year ago.

Alive with a past

No other can share

So give me some heaven

Just for a while

Angel Olsen - Spring

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