Market Volatility Bulletin: The S&P Is Trading Where It Was 12 Months Ago

Apr. 20, 2020 1:36 PM ETEEM, IWM, QQQ, SPY, XLE, USO1 Comment
The Balance of Trade profile picture
The Balance of Trade


  • US stocks are little changed in the Monday session, continuing a pattern of lower realized vols.  Spot VIX is still hugging the 40-handle.
  • Twelve months later and the S&P has basically in place.  For a buy-and-hold investor, that amounts to some real return-free risk.
  • While oil prices continue to break down, implied vol on the XLE is calming - dipping below realized vol levels.

Market Intro


US stocks are off their lowest levels of the session, with the NASDAQ 100 (QQQ) and the Russell 2K (IWM) in the green. Spot VIX has notched back up above the 40 handle.

S&P futures (SPY) struck a low of about 2810 before reversing during the session.

Thoughts on Volatility


The real story of the day has more to do with futures on the May WTI futures contract. I'll quote the CNBC report directly:

West Texas Intermediate crude for May delivery tanked 57%, or $10.52, to $7.65 per barrel, its lowest level on record. Meanwhile international benchmark, Brent crude, which has already rolled to the June contract, traded 5.2% lower at $26.62 per barrel. The June WTI contract, which expires on May 19, fell about 9% to $22.75 per barrel. The July contract was roughly 5% lower at $28 per barrel.

So while there is no shortage of shock and awe over both the percentage loss in the May WTI contract, as well as the absolute level at which the contract now trades (USO), the countervailing reality is that it's a low-volume contract at this point that is providing a rather small glimpse into the greater picture.

What is perhaps more important is the fact that the "peak driving season" contracts are still well below $30/barrel, and that after the historic OPEC agreement to dramatically cut production. An economic recovery may be in the works, but measures such as the oil market appear to be punting as to how soon we may witness such a phenomenon.

Whenever a massive bill - potentially loaded with some pork - is passed quickly, one can imagine that some perverse incentives/motivations are inevitable.

Now it may be the case that the business owner that Mr. Carroll mentions above will be disinclined to invite his employees back to work when the stimulus and support from CARES diminishes or closes out.

I tend to believe that much of the current stimulus is meant to bolster very anemic demand, which is not necessarily inflationary (under circumstances such as these). If the stimulus creates a large-scale disincentive for employees to return to work, however, wages may rise as a result, and prices on finished goods and services could in fact rise.

I am interested in hearing from readers as to how the current stimuli has led to new incentive structures for employees, business owners, etc.

Jeff Cox makes some interesting comparisons between the S&P vs. the Russell 2K, EM stocks (EEM), and the like. But there's been quite a bit of volatility in the S&P, with virtually no net change since April 2019.

This is in fact the essence of the risk-return tradeoff. When investing in risk assets such as equities, returns are only a relatively sure bet in the long run (say, at least 20 years). But in the short run, volatility is far more likely to be a bankable reality. Just so with the S&P this year.

What fascinates me is that the current S&P level is quite similar to where it was last August during the heat of the ongoing trade talks with China. Markets in general were expressing some heartburn over the tone of discussions, nervous about the impact on the global economy. Now that a devastating devourer of the global economy has in fact struck... we're in the same place. ¿Viva La Fed?

Term Structure

HV20 towers sixteen vol points over the HV10. The S&P, and risk assets broadly, are attempting to simmer rather than jerk around. Note that I am mentioning realized and not implied volatility here; this is a reflection of what has already occurred.

The VX term structure remains below the various measures of realized and spot implied volatility, suggesting a belief that markets will continue to gradually self repair. XLE implied vol (teal) vs. 20-day realized (purple)

With the continued decline in oil prices, even after the valiant attempts by OPEC and Friends to cut supply, the Energy Sector SPDR (XLE) has held up reasonably well. Implied vol has fallen markedly, and in fact not rests pretty well below the 20-day realized vol measure.

If one is of the mind that oil is going to stabilize or rise, then I suppose this set-up looks pretty reasonable. But I am struck by the fact that XLE options may be on the cheap side here, despite pretty high overall levels. I'll be examining the term structure and considering a long-vol play on this instrument.

Wrap Up

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This article was written by

The Balance of Trade profile picture
Adam Zingg, CFA offers both practical and theoretical perspectives that will benefit readers who wish to learn more about how to execute  on views or strategies that interest them.  Whatever your overarching philosophy or expertise, I believe there is value in understanding how trading works. This is perhaps especially true for investors, who often take a more philosophical, less mechanical view when it comes to their processes. It is not my goal to:1) convince you which side of the market to be on2) establish your trading time frames3) have you directly follow any specific trade ideasInstead, I aim to demonstrate how complicated sounding ideas can be simplified and accessible.  My hope is to grow your tool kit of resources, and give you healthy confidence to execute your own personalized strategy.  Trading and investment are fascinating, applicable across a wide variety of fields and disciplines.  Greater focus on targeting, execution, and exit strategies build transferable life skills.  In reading my work, it is my goal that you will consistently glean useful insights and build skills that enhance your ability to trade and make important decisions.

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.

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