Market Volatility Bulletin: Volatility Spikes As Trade Narrative Disrupts Calm

by: The Balance of Trade

Global stocks are in retreat mode as the trade dispute takes the helm again.

If it's true that US companies are paying Chinese tariff costs, then why are the Chinese retaliating?

US Treasury vol has been sneaking higher over the last month or so.

Market Intro


The action in S&P futures (SPY) was downward sloping pretty much from the outset of the overnight session. Asian markets (AAXJ) led the way, but

European equities (VGK) have experienced the worst of it, which is interesting given that it's allegedly the escalation between China (FCX) and the US (DIA, QQQ, IWM) that's got risk-assets rattled.

Spot VIX notched higher, but the gain is "only" about 12% off yesterday's close, which is not too alarming.

Thoughts on Volatility

If this is the case, then why is China retaliating? Why are we even speaking about a "trade war heating up" if the costs of the tariffs are borne by the nation that imposes the tax?

I'll readily acknowledge that a tariff is a form of raising tax revenue, and that the economic burden is split between the buyer (US consumers) and the seller (some mix of the Chinese manufacturer and the US merchandiser).

But one needs to ask who the most elastic groups are here, as the relatively inelastic parties are the ones who pay the lion's share of the tax. The very nature of the "trade war" and that we have a two-way battle suggests that Chinese firms absorb a good deal of the attendant costs.

For the time being anyway, the USD (UUP) is on the rise and US Treasury yields (IEF, TLT, AGG) are beating a path lower.

A generalized slowdown in the global macro economy could explain a good portion of the falling bond yields. I don't see this presently as a "flight to quality" issue, as vol levels are really not so high in the grand scheme of things.

We'll look at the other side of falling bond yields below, but I do believe that falling yields is stabilizing for risk assets.

"It's not a stock market, but a market of stocks." It's easy to overdo this advice.

In fact, the folks who use this line can also be heard touting "A rising ship lifts all boats." Which is it?

But the fact remains that it can make a good deal of sense to try and isolate volatility and variables to a position that you find more workable. While trade concerns are the topic du jour, you can look for products and/or spreads that mitigate some of the movements that you find to be a nuisance.

Term Structure

As the morning session draws to a close, the VX term structure is off the highs of the day, but still nearer to the top as opposed to the bottom of its range. S&P futures are bouncing (for now), but as shown earlier the action is downhill.

What I find intriguing here is how the entire term structure got in on the action, as opposed to the M1 and M2 essentially getting all the action. Naturally one can readily observe that M1 and M2 did in fact see the biggest moves; my point is that the entire futures curve is participating some.

My take is that markets find a way past the present debacle. But I do want to mention the fact that over the last month, the Treasury VIX has been gradually on the rise. Over the last two years or so this index has seemed to do its part to either shake up or assuage generalized asset volatility.

Which makes sense: if the "risk-free" asset starts to get more volatile, what does that say for assets like SPX? While I think the short-vol position (SVXY, ZIV) is the course that the market will opt for over, say, the next three to six months, I want to acknowledge that Treasury vol suggests otherwise. - UVXY Implied Volatility

UVXY enjoyed a big pop so far today - up about 8%. The implied vol reading (green) is still quite middle of the range over the past year, while realized volatility is moving higher.

Option volume on the ETP looks to be slowing down some (tan bars above), and implied is trading at a meaningful discount to historical. This suggests that options traders see the future as calmer than the recent past. If you disagree, then the UVXY options market may be a good place to look for opportunities.

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.

Thursday's activity has diverged pretty meaningfully from what we observed over the past week or so. The comment above from A&H (and much of my commentary from yesterday for that matter) doesn't appear well suited to the current session.

But we do have a holiday-shortened week ahead, and the fact is that spot VIX, while higher, has maintained its composure pretty well in the grand scheme of things.

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.