Market Volatility Bulletin: SPX Tries Out 'Buy The Dip' On Trade-Related Sell-Off

by: The Balance of Trade

All sectors of the S&P are down today as risk assets digest Trump Tariff Tweets.

Who actually remits the tax is not important according to tax incidence theory.

Watch out for rebalance decay on leveraged products here, as they can heavily dilute the impacts of those large up-moves.

Market Intro


Spot VIX is up over 25% in Monday trade after President Trump rattled financial markets with two tweets indicating that enhanced trade tariffs against China were around the corner.

US stocks (SPY, DIA, QQQ) were down quite a bit in the overnight session, but have since been mounting a steady recovery (though still down); the Russell 2K (IWM) is down only about a third of a percent amidst the commotion.

Thoughts on Volatility

Tax incidence is the economic theory that studies who bears the economic consequences of a tax. The first (of five) laws of tax incidence is "Who cares who pays?", which is to say that it doesn't matter at all which party (buyer or seller) remits the tax.

As Mr. Slaughter suggests, the true burden has more to do with relative elasticities. It is reasonable to believe that a good deal of the economic cost will be borne by Chinese producers, regardless as to whether the tax is paid by importers (otherwise, why would China even care?)

This may be one reason why the earlier sell-off is trying to reverse course rather early after the news bomb hit the Twitter feed.

Equities have gotten out in front of themselves some. Skittishness is very natural here, and a more convincing sell-off than what Monday has actually turned in so far would not have been alarming in the least.

Realized vol may kick into higher gear from extraordinary low levels, but I don't see SPX bears/vol longs really being able to kick the ball very far down the field to convert much here. This has more the earmarks of the classic "Buy the Dip" battle cry.

Not that reasons for heightened concern and concomitant structural increases to realized volatility don't exist - they most certainly do! But it's a question of how much risk markets care about red flags.

We saw plenty sell-offs sparked by trade threats over the last year, and they've never gotten that much traction. For that matter, any conciliatory statements from the Trump administration has carried the potential to launch markets into "everything's okay again" mode, making trade news at the very least a double edged sword.

Term Structure

But, at least for now, vol markets care about the drop in the SPX, as indicated by spot VIX and the VX futures curve.

As mentioned in the intro, spot VIX is up a whopping 25%. This is easier to do, however, off a low base. VX futures have risen since Friday's close, but most of the action is on the front end (which is completely normal, especially at the beginning of a scare).

Modest roll yield benefits vol longs (VXX) as of this writing, but that state of affairs could prove transitory.

Even though the raw percentage increase in EEM VIX is not quite as great as the SPX VIX, the index already featured a higher base to begin with.

If you're long vol, and you're thinking about holding your position (congrats on today's action by the way), I'd keep a close eye on VXEEM to get a sense of how much this scare really has in the way of legs. I struggle to see it lasting much more than a couple weeks and (at best) maybe two hundred SPX points. VXEEM is likely to have more of a delta to sentiment on trade-inspired volatility. UVXY 5-day price chart

Roll yield is not presently an issue for long vol (UVXY), but rebalance decay can pose its own difficulties. Leveraged products like UVXY do outstanding on days such as today (up 13.5%), but note how the price of the ETP's shares are really about the same as they were at last Wednesday's close.

Granted Friday saw a vol crush, and so a lot of Monday action is working the reversal from a large down move. But that's exactly were rebalance decay can cause the most problems: large inter-day whipsaw.

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 wanted to share an exchange from the previous MVB regarding a comment that I'd made about negative-yield debt instruments in Europe hinting that the global financial market environment is "inorganic". FL for asked for an expanded explanation relating to how I meant the term, which I provided.

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.