Market Volatility Bulletin: What Trade War?
Summary
- Stocks are giving the upside another whirl. We've been here before, but volatility does seem to be giving traders some cover.
- US-China trade is getting a lot of attention, but spillover is certainly possible. Germany is truly the exporting powerhouse.
- Tug-of-war between realized vol and VX is going to end with a very definitive loser IMHO.
Market Intro
CNBC: 11:30 AM EST
Stocks (SPY, DIA, QQQ, IWM, ACWX) are trying to put last week behind them. Indeed, the S&P 500 trades almost identical to where it did just prior to the jobs number release. In the weekend MVB, I asserted that it was actually the comments from Chair Powell that pushed stocks off the cliff. We'll see if stocks can hold their gains.
Bitcoin may call in sick today, and at least in the past (see graphic below from February 13) some have looked to relationships in return variation between stocks and cryptocurrencies. Given how volatile the asset really is, 6 percent is pretty run-of-the-mill. In any event, calm seems to be what most markets are trying for today.
Amid all the trade concerns, gold (GLD) and silver (SLV) have been remarkably range bound. Platinum and palladium, however, are enjoying a pretty meaningful bounce as we enter the afternoon session.
Thoughts on Volatility
At present most of the trade tiffs have been between the US and China. But there is scope for such "friendly banter" to expand.
Wikipedia
German exports are truly staggering when one stops to consider that Germany has a population of about 82 million - about 6% that of China, and 25% of the US. We do live in a global and connected world, and most economists would argue that this is mostly for the better.
At any rate, for better or worse, trade appears to be on the docket for items that the Trump Administration wants to address. Personally, I think at least from America's standpoint, this can be good or bad news depending on your pre-existing political persuasions. The key for this forum is to ask whether spiraling trade tensions are a true threat. If yes, then the impact on large corporations could be quite painful.
We've gotten some really excellent comments over the past several MVBs, but I wanted to cover this one as it provides room for a counter-story for vol heating up.
At some point, and certainly atom & humber doesn't indicate anytime super soon, I see a desperate rally. Regardless of whether or not this is a true bear market. Limit up, or something much like it, would not be that surprising. I have in mind the period between when Donald Trump won the election (S&P 2028 - limit down) and the next morning at the open (2155, closing higher than the prior day).
I've spoken often of muscle memory in the past, and sure there's still likely some of that. But really what I'm after here is that at present, there are a few stories (trade, tech breakdowns, rising rates) that are dominating the sphere. All it takes is a momentary bout, much like when clouds temporarily part and the sun shines bright, for animal spirits to race back into action.
Term Structure
"One of these things is not like the other". There is a real tug of war going on here, and time is not on the side of one either realized vol or implied vol. Spot presently prints fully below 30-day vol, and the VX futures trade below that, flat as can be.
VX is forward-looking in nature, whereas historical vols are just that: history. Roll favors VIX longs by a bit (VXX, UVXY, TVIX).
Jim Carroll (Tweet featured above) appears to have a hard time fighting the high realized vol reading (SVXY). I disagree. But I will agree that the short-vol cat is quickly running out of lives. Should realized vol continue in the current vein unabated, I believe the whole term structure abandons the thesis of alert-but-composed and darts northward in a hurry.
Sings of hope for volatility shorts (and equity investors) can be found in the NASDAQ VIX. If this index can be corralled, the chances for a broader recovery (and perhaps a swift one at that) rise considerably.
Coinciding with this is a convincing push lower in 10-Yr Treasury Note VIX.
The ingredients for a vol beat-down, even if temporary, are absolutely present. Now it is just a question of whether the markets can sidestep bad news for a time.
Conclusion
If this is your first time reading Market Volatility Bulletin, thanks for giving it a try. If you're a regular, we thank you for your ongoing contributions in the comments section.
We've been having some productive discussion in the comments section regarding the "natural" state of the volatility term structure. Many posit that contango is the shape that the VX futures should take most of the time. Furthermore, contango-as-insurance is one of the major themes behind this argument.
Silent Trader strikes an excellent balance with his argument below. His assertions hold a lot in common with my own as to why there is no "natural" state of vol.
My belief is that the front end of the curve is beholden to wherever spot VIX happens to be. The back end of the curve tends to trade closer the long-term spot VIX mean.
This implies that when spot VIX trades "high", backwardation is the "natural" state of the futures curve, as the back end foresees a return to more common levels. Conversely when spot trades "low", the back end is less enslaved to whatever low levels spot determines is reasonable at the current moment.
Anyhow, wherever you happen to fall on this issue, I'd love to hear your thoughts on the matter if you have more to share. Thank you to all who weighed in on this topic.
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This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
I actively trade the futures and options markets, potentially taking multiple positions on any given day, both long and short. I also hold a more traditional portfolio of stocks and bonds that I do not "trade". I do believe the S&P 500 is priced for poor forward-looking returns over a long timeframe, and so my trading activity centers around a negative delta for hedging purposes.
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Comments (11)
"If the end is fixed at the mean logic dictates that an above average VIX the term structure must be in backwardation while with a below average VIX the term structure is in contango."However, the near-term VIX on average will be lower than the long-term VIX - because of time risk, similar to the underlying options. This is the time factor which somehow keeps getting lost in this discussion. That's why most of the time, we're in contango - and any other theoretic situation would have bizarre consequences. Not sure how to explain this better...
