Market Volatility Bulletin: January Continues To Smile On Equities

by: The Balance of Trade

The potential for thawing Chinese-US trade relations has equities bubbling higher on Friday.

January has thus far been an exceptional month: actual returns can deviate quite a bit (in either direction) from long-term averages.

Current term structure is more pensive than what the tape would indicate.

Market Intro

CNBC: Friday 2:47 EST

Spot VIX is holding its own while stocks (SPY, DIA, QQQ, IWM) continue their intrepid rally higher.


According to Bloomberg, a major catalyst for today's positive movement in stocks may be on account of China extending an olive branch in attempts for trade tensions to abate. If more stories such as this one emerge over the coming weeks, it becomes more likely that risk assets can regain their footing.

Thoughts on Volatility

I've seen correlation patterns like this between, say, the Fed's monetary base and the S&P for periods such as 2008 through 2016. What I found interesting and different about the visual above is that it only captures 12.5 trading months.

The relationship is by no means perfect, and in fact the pattern really only looks to be compelling toward the back half of last year.

Going forward, I think trade resolutions could well take center stage as what drives valuations.

What a January (and we're not done yet!). It's fair to enjoy this market while it lasts, but do keep in mind that spot VIX, while down a great deal, is still tracking near 18. It's fair to say that a volatility resurgence is in the cards, even if it cannot command the same level of duration or intensity as Q4 '18.

I enjoyed this piece on Seeking Alpha: The Average Return Doesn't Exist! Author Jeroen Blokland points out that actual annual Dow Jones returns going back to the year 1900 cast a wide dispersion around the average long-term range of 5-10% that many investors and analysts think of as being "common".

Actual returns can vary quite widely from our intuition, either for better or for worse.

Term Structure

The VX term structure today finds its recent counterparts in the fourth quarter of 2018 (as well as April '18). When one considers how calm intraday activity has been in the S&P over the last month or so, it is remarkable that VX futures are as high as they are.

We'll need to see a continued period of calm in order to get the term structures to the region witnessed between May and September.

Implied correlations between on options on individual S&P names is still on the high side. The KCJ index (pictures above) lasts until November '19, and if history is a guide, we'll see correlations get whippier as the months pass by.

A drop in this index would likely signal more room for vol to take a leg down here.

Atom & Humber points out that it's worthwhile to to a glance at other markets (e.g. GLD) if one would like to use options to try on a thesis. Naturally S&P vol is where the ETPs are (VXXB, UVXY, SVXY, ZIV). The GVZ is an index that measures the VIX of GLD, and it's on the low side at present.

My take is that this run-up should be taken seriously, but such action is quite perilous in practice. If news flow can give global risk assets the support they need, then I think we may in fact see something like a recovery. Furthermore, the sell-off in December could very easily qualify as "oversold", and so we may just be getting the other side of that.

Still, the term structure seems to be taking a resurgence reasonably seriously; I think that's the right call here. In my view it is time to either try out another market, or to feather in to some long-vol positions for equities. Some SPY put spreads, for those with something of a bearish bent here, make sense from my point of view.


If this is your first time reading Market Volatility Bulletin, thanks for giving it a try. If you're a regular, I thank you for your ongoing contributions in the comments section.

Robin offers his thoughts in the prior MVB. I agree that the doves at the Fed have 'seized the high ground', and for the time being that may encourage risk taking. More than anything, I like the last sentence: FOMO has gripped the tape this month.

Thank you for reading.

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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.