Market Volatility Bulletin: Will Volatility Make A Comeback?

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Includes: AGG, DIA, IEF, IWM, QQQ, SPY, TLT, UVXY, VXXB
by: The Balance of Trade
Summary

US equities didn't like the tone from Fed Chair Powell.

I argue that the economy has undergone a very significant transition.

Vol is enjoying a boost, but I think this rip is more of a sell than a hold.

Market Intro

CNBC: 11:48AM EST

Seemingly invincible US equities (SPY, DIA, QQQ, IWM) are sustaining some damage for a second day, presumably based on comments from Chair Powell yesterday that were not sufficiently dovish for investors in risk assets.

Spot VIX printed just below 16 as Thursday afternoon's trading session commenced, after hitting lows in the mid-twelves earlier in the week.

Thoughts on Volatility

While investors may indeed be bullish on USTs, the ten-year yield (IEF, TLT, AGG) has notched up about 20 basis points or so over the last month; falling yields were arguably a benefactor to the heady recovery in risk assets since this past December.

While the Sentiment Index may be on the rise, keep in mind that it has been doing so since late 2017, arguably not the best time to have been bullish on Treasuries.

So the Fed is on hold, much to the chagrin of stocks (for the time being, anyhow). But the Fed may have good reason not to cave to market pressures.

Not only has the monetary body's policy toolkit changed a great deal over the last several years, but the dynamics that drive both the economy and inflation may also have changed. Today we have fewer labor unions that can argue for inflation-linked wage increases, and indeed the labor market overall commands a lower percentage of GDP. Inflation may have an easier time of making a surprise visit than it has in the past due to these shifting variable weights. Fed refusal to cut may be kicking up some "vol dust" today, but perhaps to the benefit of markets down the road.

I love these kinds of surveys and discussions, and I encourage you to cast your vote. That said, we want to bear in mind that polls for which voters volunteer whether or not to answer questions are notoriously prone to statistical bias.

The attitudes of Americans go a long way to shaping the future of our country. Past trajectories for capital markets, debt levels, and government policies are not necessarily prognosticators of what the future will bring. In fact, often the future can be a direct revolt against the patterns and flows of the past.

Term Structure

So we're finally seeing spot VIX get a lift, after what no doubt seems to long-vol position holders (VXXB, UVXY) an eternity.

In the grand scheme of things, we're looking at a decent selloff in stocks over the last couple days, and spot VIX is reacting calmly for the product that it is.

I don't see this as really having legs though, beyond maybe some follow through over the course of a couple weeks tops.

One important explanation for my reasoning is that Treasury VIX looks to be back on the descendant, and the absolute level is still just not that worrisome. Some of the major sustainable blow-ups to SPX vol have strongly coincided (and indeed been led by) increases in Treasury vol.

This time 'round, SPX vol looks more to be on its own. While some kind of reactive incident for US stocks has arguably been long overdue, there has been precious little record over the last decade of equities sustaining a "panic" on their own (May 6, 2010 maybe).

MarketChameleon.com: VXXB Implied Volatility

VXXB is getting a small bounce on vol pickup, but nothing too drastic. In fact, the product currently trades about where it did just last week. This is the danger of the present roll-decay environment that plagues long-vol holders (see comment below from atom&humber).

The modest bump to implied vol on VXXB options supports the notion that traders are not taking the sell-off too seriously, as there doesn't seem to be much motivation to get out in front of vol on an upswing.

Wrap Up

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.

I'd like to give a quick shout out both to oldcastle (6th comment here on SA: Keep 'em coming!) and atom&humber for an excellent question and answer exchange.

Covered call strategies are not necessarily bad, but one needs to understand the impact of extreme contango or backwardation on the options pricing

(options are priced off futures, not the actual underlying).

Thank you for reading.

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 time frame, and so my trading activity centers around a negative delta for hedging purposes.