Feb

8

Stronger Stocks Pull Volatility Down to 8 Month Low

Filed Under Market Snapshots, Option Trading Articles 

Implied volatility continued to suffer as issues related to Greece have been trumped by better than expected economic data and strong US earnings.  During 2011, traders experienced close to 30 days of more than 300 points swings in the Dow Industrials compared to zero so far in 2012.  On Tuesday, the Dow closed at its highest level since 2008.

The VIX volatility index, which measures the “at the money” implied volatility of the S&P 500 Index, is settling into a new lower range between 20%, and 17%.  This past Friday’s employment report gave investor’s confidence that the markets will continue to grind higher, which took additional premium out of the VIX.

Last Friday’s employment report could have been a turning point in market sentiment, which could hold for the balance of February.  According to the Department of Labor, non-farm payrolls increased by 243,000 compared to the 125,000 expected by economists.  Additionally, the employment rate, which is a household measure of employment, dipped to 8.3%, compared to the 8.6% as expected.  Employment has now shown double digit growth for the last three months, averaging over 200,000 jobs which is in line with 3% growth.  Many doubters of the equity rally in January where waiting for a negative jobs number to lean into short positions, which has now been erased for the short term.

One of the more interesting increases in stock implied volatility is Sears Holdings (NYSE:SHLD).  Sears is expected to release earnings on February 20, 2012.  Implied volatility on the nearby contract has surged to 111%, which is 5 volatility percentage points above last week’s level.  The range on implied volatility for Sears is 30% to 115%.  Historical volatility using a range method is 78% to 118%.  Current implied volatility is extremely high and trading above the prints for historical volatility which signals an opportunity to sell Sears implied vol.

Despite issues with Iran and a potential embargo that could lead to a closing of the strait of Hormuz, oil prices remain below $100 per barrel.  Similar to the change in the spread of Brent and WTI during the Libyan crisis, Brent prices have continue to remain high.  The spread is now $20 dollars per barrel, which Brent trading near $117.  The oversupply of WTI crude oil has lead to relative depressed prices when compared to Brent and has pushed the OVX crude oil implied volatility index to 32%, which is the lowest seen in the last 52 weeks.

During the balance of this week, market participants will focus on the ECB and the BOE, along with US earnings which continue to impress.  US economic data that will be of interest is retail sales, which has not shown the bounce expected after solid holiday sales.  Many stocks have broken out to the upside, and have pulled the major averages higher.  The markets are likely going to correct, twice between now and late April, which gives investors time to look for cheap volatility.

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