A DOUBLE EDGED SWORD
Over the past 28 days following the US Presidential election, the S&P has been on a tear returning more than 6% in a little more than 5 weeks time.
For the sake of context, the index returned just over 1.5% for the one year prior to the election while the 28 day post-election rally is in the 90th percentile of returns over the same time period since the inception of the S&P 500 (the orange line in the histogram represents the most recent 28 day performance).
It is important to note that not all rallies are created equal, however. The majority of 28 day return distributions to the right of our current mark came on the heels of downside volatility when prices are subject to wild fluctuations in both directions. That has not been the case in the fall of 2016 though as this rally is almost a pure breakout following an unexpected outcome in the election that is expected to favor corporate profitability.
Typically, increases in the price of volatility are associated with bear markets - as prices move lower with greater speed, traders look to insure positions with derivatives whose own prices rise as a function of increased demand and rising levels of implied (or expected) volatility. Bull markets, on the other hand, tend to play out over a longer cycle; as the saying goes - fear is a greater motivation than greed. With the longer bull market cycle, demand spikes for options or rapid rises in expected volatility are not as common so prices tend to stay low.
Again, this rally is different. The price of volatility - while not spiking - has seen increases on days when the market is making new highs.
In looking at the SPY 1 week at-the-money put options, the historical volatility for this contract is typically south of 10%; however, this morning the implied volatility was pricing at more than 15%... a 50% premium to historical vol! Also interesting has been the performance of the VIX. On December 7th, for example, the S&P rallied close 1.3% for the day; typically, this would not be a cause for a rise in volatility but the VIX actually rose more than 3.5% that day.
What this indicates to me is that markets are pricing in an extended period of price fluctuations and not just to the downside. The post-election rally has plenty of steam still and is not showing any technical signs of slowing down. However, I personally believe the market is also pricing in an increased headline risk premium. Given the unorthodox nature of this transition in political power, a single headline could wildly disrupt markets too.
Over the past 28 days following the US Presidential election, the S&P has been on a tear returning more than 6% in a little more than 5 weeks time.
For the sake of context, the index returned just over 1.5% for the one year prior to the election while the 28 day post-election rally is in the 90th percentile of returns over the same time period since the inception of the S&P 500 (the orange line in the histogram represents the most recent 28 day performance).
It is important to note that not all rallies are created equal, however. The majority of 28 day return distributions to the right of our current mark came on the heels of downside volatility when prices are subject to wild fluctuations in both directions. That has not been the case in the fall of 2016 though as this rally is almost a pure breakout following an unexpected outcome in the election that is expected to favor corporate profitability.
Typically, increases in the price of volatility are associated with bear markets - as prices move lower with greater speed, traders look to insure positions with derivatives whose own prices rise as a function of increased demand and rising levels of implied (or expected) volatility. Bull markets, on the other hand, tend to play out over a longer cycle; as the saying goes - fear is a greater motivation than greed. With the longer bull market cycle, demand spikes for options or rapid rises in expected volatility are not as common so prices tend to stay low.
Again, this rally is different. The price of volatility - while not spiking - has seen increases on days when the market is making new highs.
In looking at the SPY 1 week at-the-money put options, the historical volatility for this contract is typically south of 10%; however, this morning the implied volatility was pricing at more than 15%... a 50% premium to historical vol! Also interesting has been the performance of the VIX. On December 7th, for example, the S&P rallied close 1.3% for the day; typically, this would not be a cause for a rise in volatility but the VIX actually rose more than 3.5% that day.
What this indicates to me is that markets are pricing in an extended period of price fluctuations and not just to the downside. The post-election rally has plenty of steam still and is not showing any technical signs of slowing down. However, I personally believe the market is also pricing in an increased headline risk premium. Given the unorthodox nature of this transition in political power, a single headline could wildly disrupt markets too.
Comments
Post a Comment