Volatility Markets Flash Signs of Distress After Turbulent Week

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Volatility Markets Flash Signs of Distress After Turbulent Week
Credit: © Reuters.

(Bloomberg) -- Between a fresh surge in coronavirus cases and disappointment over Big Tech’s earnings, there are suddenly a lot of reasons for investors to be fearful.

The volatility curve is flashing a sign of distress last seen in April, and exchange-traded funds that bet on turbulence saw heavy trading in the pre-market this morning. Systematic strategies that use volatility as a trigger are poised to sell more, which could potentially add more pressure on the market, according to analysts at Nomura Holdings (NYSE: NMR ) Inc.

After global shares surged to all-time highs less than two months ago, investors are now grappling with a reality check. European authorities have imposed strict lockdowns, U.S. virus cases hit a record and tech giants from Apple Inc (NASDAQ: AAPL ). to Amazon.com Inc (NASDAQ: AMZN ). are declining. For the S&P 500, it’s shaping up to be the worst week since March.

The equity benchmark dropped 0.5% as of 9:30 a.m. in New York. Among the most-traded ETFs before the opening bell was a product that shorts U.S. mega-cap tech stocks and another betting on higher short-term volatility.

In the options market, the curve of futures tied to the Cboe Volatility Index has remained in backwardation, or a downward sloping shape that typically only appears when market anxiety is high. In terms of the gap between one- and six-month contracts, the curve has not been in such an anomalous state since April, according to Evercore ISI.

“Election Day risk pricing has rebounded and likely reflects both event and virus uncertainty,” Stuart Kaiser, a strategist at UBS Group AG (SIX: UBSG ) wrote in a note. “A drawn-out election outcome is still possible, and persistent growth and virus risks put a floor under the VIX near term.”

The VVIX, a measure of the implied volatility of the VIX, has spiked on strong demand for options on Wall Street’s fear gauge. More than $12 million was traded yesterday on calls expiring Nov. 18 that benefit if the VIX rises in the next two weeks.

Giant Trade Shakes Up VIX Options, Then Disappears: Taking Stock

Analysts are also drawing comparisons between VIX metrics now and four years ago.

On the Friday before the 2016 election, the volatility risk premium for the S&P 500 was near the highest level in the past decade, according to analysts at BNP Paribas (OTC: BNPQY ) SA. The premium, a measure of the difference between realized and expected swings in the equity gauge, is similarly elevated now.

Some volatility strategies will likely have to de-risk after the recent bout of market turmoil, according to Nomura’s Charlie McElligott. He estimates that Wednesday’s rout prompted about $20 billion of selling in the futures market from algorithmic traders using volatility-sensitive strategies.

“Positions (in light of volatility) are now too large and have to be sized-down,” McElligott wrote on Thursday.

©2020 Bloomberg L.P.


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