Market Volatility Bulletin: SPX Shakes Off Overnight Session, While Skew Gives The Greenlight

Market Intro

Market Volatility Bulletin: SPX Shakes Off Overnight Session, While Skew Gives The Greenlight

CNBC: 11:33AM EST

Utilities (XLU) is the only sector down (-.15%) thus far in Thursday trade, while the rest of the SPDRs are fuelled by hope that this week’s trade discussions between the US and China will be fruitful. Financials (XLF) lead the way, up 1.55%.

Spot VIX has dipped below the 18 handle on market optimism.

Thoughts on Volatility

Market Volatility Bulletin: SPX Shakes Off Overnight Session, While Skew Gives The Greenlight

Agreed Chris. There’s been a lot of simple random up-down blips in the markets over the last months that one should likely just ascribe to markets being markets. But, so often, the media attribute any and all moves of late to the trade talks.

But, now, we really do have reason to believe that risk assets will reflect the impact of these discussions. The tone is positive, no question. But one only needs to go back to the overnight session (S&P futs were down to around 2,880 at one point) to see that sentiment can change very rapidly.

Market Volatility Bulletin: SPX Shakes Off Overnight Session, While Skew Gives The Greenlight

Believe it or not, monetary policy – not trade – has likely been the larger influencer of risk appetite since the December ’18 lows, just before Chair Powell reversed course on monetary policy.

Since then, risk assets have been rewarded, as shown in the metric above. Volatility readings across most asset classes have fallen markedly on the change to the Fed’s policy and messaging.

For those looking for the next ramp higher in stocks, however, a good strong trade resolution would probably do a lot to clinch the breakout. A combination of easy money and resolved trade would most likely do much to soothe market angst, sending vol readings down into the lower teens.

Market Volatility Bulletin: SPX Shakes Off Overnight Session, While Skew Gives The Greenlight

This meme has been around a very long time. My dad (almost 70) once told me that he read about this in the 1980s, with attendant explanation to why the stock market is doomed.

I think that it’s got some merit to the argument, by the way. But we’ve seen companies rush to the fore to buy back their own shares, acting as a countervailing force to bolster demand.

“Markets find a way.”

Term Structure

Market Volatility Bulletin: SPX Shakes Off Overnight Session, While Skew Gives The Greenlight

Across the board, we are looking at some pretty stinking flat measures of contango or roll yield. Each of these metrics is near the zero line, which indicates that, for the time being, there is no “time decay” on these instruments, whether you are long (VXX, UVXY) or short (SVXY, ZIV) of volatility.

Market Volatility Bulletin: SPX Shakes Off Overnight Session, While Skew Gives The Greenlight

ThinkOrSwim: 1Yr SPX Skew

I expected the CBOE Skew to be higher than it was when I checked on it today. Especially so, given the overnight action and the lunge higher in equities today.

To be clear, SKEW is well off the lows of last week, but it is by no means running hot on the “danger” signal. The indicator is relaying that upside relative to downside in the SPX is pretty balanced here. Three cheers for trade talks!

Market Volatility Bulletin: SPX Shakes Off Overnight Session, While Skew Gives The Greenlight

MarketChameleon: VXX Term Structure

For those looking to use VXX either to just get long vol (remember that roll decay is quite low at present) or to hedge equities, the implied volatility profile on the VXX looks to flatten out quite a bit after 60 days.

If we examine the scenario for a moment that you see the trade talks ultimately not bearing much fruit (like say 45 days out), you could short the near-dated (20 or 30-day) call, buy two of the 45-day calls, and then short a final 60-day call. Such a trade is known as a “Time Fly”.

Such a strategy would defray the early impact of theta decay (short the near-dated call), while still potentially giving you some benefit from gamma/vega (depending on the actual options you choose).

Wrap Up

Skew is giving the green light to further gains. The term structure is pretty flat. It’s not a bad time to snap up some volatility protection, or play up the term structure with time flies based on the current shape of the VXX curve.

Optimism may be a tad early here, but the tone at least looks encouraging.

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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.