Alarm Bells Ringing In Options Market Point To Volatility Ahead
Alarm bells are ringing in the U.S. equity-options market, and to Sundial Capital Research Inc. that points to one thing: a spike in volatility ahead.
Extreme readings in indicators such as the cost of S&P 500 Index hedges, short-volatility positioning and U.S. equity put-call ratios all suggest investor complacency is at exaggerated levels. The Cboe Volatility Index or VIX has fallen almost 40% from its October high as equities rallied to fresh peaks on a surge in optimism over a potential U.S.-China trade deal.
“A handful of indicators suggest a high probability of an ‘event’,” wrote Sundial founder Jason Goepfert in a note to clients Tuesday. “It doesn’t necessarily mean stocks will decline, but it does seem to be a good bet that at some point the VIX will jump.”
Here is a look at the options signals causing concern:
The difference in pricing of medium-term volatility futures relative to their short-term equivalents suggests investors are expecting more price swings ahead. The ratio of the four-month VIX contract to its two-month counterpart has risen to the highest since January 2018.
The renewed positive sentiment toward a trade deal has reduced demand for protection from a U.S. stocks sell-off. That has pushed down the premium investors pay for bearish put options over bullish calls. The S&P 500’s skew, a measure of that difference, has fallen well below average levels and is not far off its low for the year.
Hedge funds betting that the risk-on market mood will continue have pushed wagers on a decline in equity volatility into uncharted territory. Net-short speculative positions in VIX futures surpassed 200,000 contracts for the first time on record, according to the latest Commodity Futures Trading Commission data through Nov. 5.
A Cboe gauge measuring the volume of bearish options bets relative to bullish ones for U.S. single stocks is also highlighting investor complacency. The indicator’s 10-day moving average hit the lowest level in more than a year last week. The gauge can often be a contrarian signal for equity markets.
The signals come as wealthy people around the globe are hunkering down for a potentially turbulent 2020, according to the latest survey from UBS Global Wealth Management. A majority of rich investors expect a significant drop in markets before the end of next year and almost four-fifths of respondents say volatility is likely to increase.