Market Volatility Bulletin: VIX Savagely Beaten Down As Markets Look For Resolution To Trade Dispute

by: The Balance of Trade

Despite considerable intraday volatility, stocks have clawed back earlier losses: VIX takes it hard.

Tariffs can be an effective bargaining chip in the current negotiations, but let's not overstate the benefits of tariffs on an ongoing basis.

For the first time in awhile, a wide trading range for VX futures looks like more than just wishful thinking on the part of the long-vol view.

Market Intro

CNBC: Fri 3:01PM EST

US stocks (SPY, DIA, QQQ, IWM) endured a roller coaster day of trade on Friday as we approach the close. Spot VIX is down nearly 13% on the day.

Trade tariffs were set in place as of midnight on Friday, causing a tumultuous dip in the early session. Since then, markets are looking for reason to believe that the US and China will find a mutually agreeable solution to the ongoing trade disputes.

Thoughts on Volatility

Inflation is where the real risk lives (not trade). A pick-up in this metric (actually, core PCE) is where the Fed finds themselves hamstrung, and then cannot afford either actual or market-perceived dovishness.

Michael Ashton is one of my favorites for updates on inflation. It appears that the last two readings have been in the middle range, which is good news when one considers the positive GDP and NFP prints that were recently released.

Tame inflation is one of the most important foundations for a sustainable low volatility environment.

Agree and disagree. The basic premise is sound. Earlier in the week I mentioned tax incidence, the economic concept of who bears the economic burden of a tax.

The US is a large, wealthy economy. We want free markets, and it's reasonable to assume that both consumers and producers will share the responsibility of the physical and political infrastructure that makes those markets possible (so in that respect I agree with Stevie Vixx).

However, wealth is created through trade. We shouldn't cheer or celebrate tariffs or try to justify them as an ongoing instrument (they are economically inefficient as a mechanism for raising tax revenue). If tariffs are a temporary bargaining chip to get closer to balanced trade, then I'm all for them.

Lance Roberts brings up an important risk factor at play. It was vogue back in 2010-2012 to talk about how corporate America had cleaned up its act and deleveraged its balance sheet in response to the GFC.

You simply cannot claim that anymore. Corporations have had both the motive and the means to lever up their balance sheets. This is especially the case if you strip out companies from broader indexes that carry gigantic cash balances (e.g. AAPL).

While this problem most certainly does have the capacity to stir up plenty of trouble in retirement portfolios and trading accounts, I don't think it can ripple through the economy the way the housing crisis did. It's more contained in that regard.

Term Structure Spot VIX trading range

Even when the Dow was down around 300 points in the early Friday session, spot VIX and the VX term structure weren't quite buying the panic (at least for this trading day). That can reverse course at any time, but markets are (perhaps surprisingly) looking for reasons to sell the rally for the time being.

I'm frankly surprised that vol traders wouldn't be more nervous about another weekend ambush such as the one encountered this past week.

This is a close-up of the term structure. I've purposely not included other metrics such as HV20 so that we can zoom in on the futures relative to spot VIX.

Very modest roll yield in favor of vol shorts (SVXY, ZIV) here. The term structure certainly sports an interesting posture at the moment, but I should point out that this is just a funny-looking flat futures curve: the gap between the lowest contract (M1) and the highest (M6&M7) is a mere .52 vol points.

Spot VIX has whipped around a great deal over the last week, and VX futures traders are looking to make heads or tails of the situation.

It's strange to me that risk assets such as SPX would seek to rebound into the weekend, but that would recommend a low(ish) spot VIX with a high roll yield.

So is this "game over" for long-vol products like VXX or UVXY? I suspect not. In fact, it looks to me like we've got some real potential for ping-ponging in the vol space, as trade issues take to the fore and then recede into the background over the next few weeks.

The point I want to make here is that only one short week ago, there really wasn't a heck of a lot of reason to expect the markets to react to almost anything. SPX had gotten locked into a pattern where nothing could hold it back or make it fret for more than a few hours. For now, it appears there's at least something to stir markets, in either a positive or negative direction.

Final note here: early in the Friday session both SPX and VIX were down pretty meaningfully. That's pretty rare. It wouldn't surprise me much if we saw some strong upside over the next few sessions without a heck of a lot of giveback from spot or the M1.

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.

Thank you, Estoril, for your post on the most recent MVB. Atom&Humber had an excellent response to this, and we're seeing some of his insight playing out in Friday's session.

Estoril makes some strong points. In particular I think he's spot on with hot inflation numbers, should they materialize (in keeping with my earlier comments in this edition).

The trouble is that shorting vol can be very profitable precisely when roll yield is high, and that's frequently at the bottom of its range (around 13 and below).

Thanks 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.