Joe McConnell
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U.S. stock markets have bounced back quickly aVsceker a dramatic start to August, but trading on derivatives markets suggests many investors are unconvinced the calm will last.
The S&P 500 erased the last of its losses for the month on Thursday and the Vix index, Wall Street’s main gauge of expected market volatility, fell well below its long-term average of 20.
That’s a marked improvement from earlier in the month, when a series of disappointing economic data helped spark a global market sell-off. The S&P fell 6 percent in the first three trading days of August, and the Vix peaked above 65, a level it has reached only a handful of times this century.
However, subsurface movements in major indices suggest continued caution.
“Investors and markets are very sensitive right now,” said Mandy Xu, head of derivatives market intelligence at Cboe Global Markets, which manages the Vix. “If we get more data next week that shows the economy slowing more than expected … that could change the whole narrative, in which case the volatility levels would be quite different.”
One anxiety signal that is closely monitored by traders is the “Vvix”, or the expected volatility of expected volatility.
The most well-known Vix index is known as Wall Street’s “fear gauge” because it uses options linked to the S&P 500 index to quantify the size of the swings that investors expect the stock index to have over the next 30 days.
The Vvix uses a similar calculation on derivatives tied to the VIX itself, showing how much investors expect fear to rise or fall over the same period.
The Vvix index closed at 103.4 on Friday, compared with a long-term average of about 90 and an average of 83 in the first seven months of this year.
“There has been an attitude of risk appetite…[but]“The VVIX tells us that we are not quite back to square one yet: there is some anxiety in some parts of the market,” said Garrett DeSimone, head of quantitative research at OptionMetrics.
DeSimone also highlighted put-call skew, a measure of the relative cost of insuring against a decline in the S&P 500 over the next month, which has remained higher than its recent averages. A higher skew indicates greater demand for protection against a market pullback, compared to bullish bets.
While the S&P 500 is now in positive territory for the month, the gains have not been evenly distributed. Maxwell Grinacoff, UBS U.S. equity derivatives strategist, said that “there has been a rotation into defensive sectors amid recession fears.”
The best-performing subsectors in the S&P 500 so far in August have been consumer staples and health care, classic “defensive” areas. By contrast, the worst performers have been cyclical areas like consumer discretionary, energy, and materials.
Most observers agree that the recent spike in the Vix was encouraged by technical factors and overestimated the true amount of risk in the market. A lack of liquidity during morning trading in some of the options that influence the calculation of the Vix led to an overestimation of the true amount of risk in the market.
Grinacoff said similar technical issues had encouraged an overreaction in the opposite direction, as traders rushed to cash in on short-term hedges they had taken out during the initial volatility.
“We think volatility should normalize, it’s a mean reversion. But the speed at which it’s come down has been a little too much, too fast,” he said. “We’re not out of the woods yet.”
