Jan

5

Volatility Softens as 2012 Begins

Filed Under Market Snapshots, Option Trading Articles 

US Markets are beginning to disconnect from many of the European bourses as economic data continues to show that the US economy is gain traction which could spill over into corporate profits.  In Early December, if the Euro dropped more than a big figure, the S&P 500 would decline as least a percent, and the VIX would shoot higher, pushing up implied volatility premiums.  The question on many traders minds is whether the US can disconnect from Europe.Volatility Softens as 2012 Begins

Implied volatility for the benchmark S&P 500 Index traded in a large range reflecting trepidation during times of stress throughout 2011.  The VIX volatility index, which tracks the “at the money” mean of puts and calls on the S&P 500 index hit a high of nearly 48% during early August and then again in mid October.  Fears over European debt and the ability of Greece, Portugal, Spain and Italy to pay their debts created the need for portfolio managers to purchase downside protection.  Support on the VIX has remained near 22%, which is below the longer term 200-day moving average near 26%

Unfortunately, many of the issues that plague European sovereignty has not gone away.  Europe needs a fiscal union to end overspending in many of its financially troubled countries.  Creating a Eurobond and a lender of last resort will likely be the only path that could stabilize Europe.  It is difficult to believe that the US will be able to forge on without help from Europe, but declining rates in China could be the impetus needed for further upside in US markets.

Economic data will likely be the main focus for US investors during the first week of the new year.  Manufacturing data released on the first trading day of 2012 showed a better than expected growth.  The ISM PMI increased to an index level of 53.9.  Analysts estimates averaged an increase to 53.0. The employment index, a highly scrutinized sub index, increased to 55.1 in December from 51.8.

Employment will also likely be a strong driver of US capital markets.  On Thursday, investors absorbed better than expected private sector employment data.  According to ADP and Macro Economic Advisors private sector employment grew at 325,000 in December, compared to the 175,000 expected by economists.  Historically this number has been the largest during the year, but the trajectory of growth in employment is very positive.  Investors will be focusing on Friday’s BLS employment report to fully gauge the current employment situation.

The Nasdaq 100 is an interesting benchmark for implied volatility given the range of expectations for earnings.  Recent disappointment from Oracle and RIMM have supplied historical volatility.   The 30-day implied average of at the money volatility is down week over week to 21.05%.  The 52-week range is from 43.18 and the low is 13.50.  A sustained rally will take implied volatility lower, but on a relative basis volatility is trading on the lower end of the 52-week range.  During the last two summers, EU debt woes took implied volatility higher, after making annual lows during the highs in stock prices in late April 2010.

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