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US stock markets have rebounded quickly after a dramatic start to August but trading in derivatives markets suggests many investors are not convinced the calm will last.
By Thursday the S&P 500 had erased the last of its month-to-date losses and the Vix index — Wall Street’s main gauge of expected market volatility — had fallen well below its long-term average of 20.
That is a marked improvement from the start of the month, when a series of disappointing economic data helped spark a global market sell-off. The S&P fell 6 per cent in the first three trading days of August and the Vix peaked above 65 — a level only reached a handful of times this century.
However, moves beneath the surface of the headline indices point to continued caution.
“Investors and markets are very sensitive right now,” said Mandy Xu, head of derivatives market intelligence at Cboe Global Markets, which operates the Vix. “If next week we got more data that showed the economy slowing more than expected . . . that could shift the whole narrative, in which case volatility levels would be quite different.”
One sign of anxiety that is being closely watched by traders is the “Vvix” — the expected volatility of expected volatility.
The more well-known Vix index is known as Wall Street’s “fear gauge” because it uses options tied to the S&P 500 to quantify how much investors expect the stock index to swing 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 and fall over the same period.
The Vvix closed on Friday at 103.4, compared with a long-term average of about 90, and an average of 83 for the first seven months of this year.
“There’s been a risk-on attitude . . . [but] the Vvix is saying we’re not fully back to where we started — there’s a little bit of anxiety sitting in pockets of the market,” said Garrett DeSimone, head of quantitative research at OptionMetrics.
DeSimone also pointed to the put-call skew — a way of measuring 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 points to increased demand for protection against a market pullback, compared with bullish bets.
Although the S&P 500 is now in positive territory for the month, the gains have not been evenly distributed. Maxwell Grinacoff, US equity derivatives strategist at UBS, said “there has been rotation into defensive sectors amid recession fears”.
The best performing subsectors in the S&P 500 so far in August were consumer staples and healthcare, classic “defensive” areas. In contrast, the worst-performing were cyclical areas such as consumer discretionary, energy and materials.
Most observers agree that the Vix’s recent peak was encouraged by technical factors and overstated the true amount of risk in the market. A lack of liquidity during early-morning trading in some of the options that influence the Vix calculation caused it to overstate 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 monetise short-term hedges they had taken out during the initial volatility.
“We do think that volatility should normalise, it is mean reverting. But the speed at which it came down was a bit too far too fast,” he said. “We’re still not out of the woods yet.”
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