Market Volatility Bulletin: Armistice Day

by: The Balance of Trade

Global equities are celebrating the news of a suspension in trade hostilities between the US and China.

The term structure is flat, but spot VIX is at the low end of its trading range.

Thanks to readers for substantive Q&A.

Market Intro

CNBC: 12:57 PM EST

A temporary hold has been placed in the ongoing trade saga, and while off their highs, US equities (SPY, DIA, QQQ, IWM) are taking this time to partake of some holiday cheer.

The cease will last for ninety days. Global shares are enjoying a boost (ACWI).

One potential result of this pause in negotiations is a weakening in the dollar (UUP). In particular, the USD:CNY pair jumped quite favorably in favor of the yuan.

Spot volatility (VXX) took a pretty substantive spill, and vol traders may look to reload here soon. Having said that, this is a continuation of a pattern of steadily falling volatility over the last couple weeks.

Thoughts on Volatility

I happen to disagree on both counts. Policy error does not necessarily account for short-term vs. long-term considerations.

Rates were kept at state-of-emergency lows for a very long time, and while times may or may not be booming, hardly anyone would opine that the US economy is in horrific state (at least not by standard metrics).

Of course, it is possible that we're headed for a slowdown… but who is "we"? The US? Europe? China?

The S&P has enjoyed something of a rebound on Monday, though a fair bit of that initial pre-market gain has at this time been given back.

But credit spreads do matter. Arguably one of the important reasons that 2016 did not get nastier was the gigantic rebound in oil (USO) and commodities more broadly.

It will be interesting to see how black gold fares here, and if there is an impact on spreads. I do believe that it would be difficult for global stocks to rally in the face of widening spreads.

It looks as though we actually have something resembling a wall of worry. The S&P is hitting a pretty real resistance area in the 2,790-2,820 region. Recall that at the beginning of November, VIX readings were fairly akin to what we're seeing now.

Term Structure

Spot VIX is definitely on the decline, down about 9% from Friday's close. But the term structure is still pretty flat, really only .9 vol points wide.

I think that if you've been short vol (SVXY) over the last week or so, then congratulations, and think about the range of vol over the last couple months.

We're near the lows of that range, and it wouldn't surprise me a bit if we at least bounced in a narrower zone of spot VIX 14-21 before seeing any true death spiral lower (if we get one at all, which is a big "if").

While the "trade war" armistice was greeted positively in the US, the drop in EM (EEM) vol was even more pronounced.

For the short vol trade to work, there probably needs to be a reasonable amount of cooperation among several markets. A vol dump in SPX alone is not likely to be sustainable if other volatility indexes remain elevated.

Intraday volatility is still arguably on the high side. Obviously, we got a big piece of news over the weekend, and so I am not saying that every day has been like this. Still, ES futures hit a high for the day of 2,813.5, and have since retreated in a meaningful way.

In light of the resistance area that stocks are testing, this is perhaps natural. But the short vol trade is not (nor is it ever) in the "all clear zone".


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Reader "Forward Learning" asked a question relating to rebalance risk vs. roll decay. Alan248 responded in a helpful way. Thanks to both of you for facilitating a helpful process of Q&A for this bulletin, as it adds tremendously to the value.

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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.

Additional disclosure: 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.