Market volatility reflects AI trade anxiety ahead of Mag 7 earnings, says Cboe's Xu

Key Concepts

• SIBO Volatility Index (VIX): A measure of broad market volatility.
• VIX EQ (Single Stock Volatility Index): An index measuring volatility in individual stocks.
• VIX EQ - VIX Spread: The difference between single stock volatility and broad market volatility, indicating additional volatility priced into individual names.
• Market Cap Weighted: An index calculation where larger companies have a greater influence on the index's movement.
• Dispersion: The phenomenon where individual stocks exhibit significant volatility, but their uncorrelated movements result in muted index-level volatility.
• Meme Stocks: Stocks that experience extraordinary volatility, often driven by social media sentiment, and are not typically reflected in broad volatility indices like VIX EQ.
• Hedging Demand: Investors buying downside protection (e.g., put options) to lock in gains or mitigate potential losses.
• Fixed Income Market: The market for debt securities, including government bonds (Treasuries).
• Real Rates: Interest rates adjusted for inflation.
• Financial Conditions: The ease with which businesses and consumers can access credit and financial services.
• SPY (S&P 500 ETF): An exchange-traded fund that tracks the S&P 500 index.
• At-the-money (ATM) Options: Options contracts whose strike price is equal to the current market price of the underlying asset.
• VIX One Day Index: A measure of expected volatility over the next 24 hours.
• CPI (Consumer Price Index): A measure of inflation.

SIBO Volatility Index and Underlying Market Dynamics

The SIBO Volatility Index (VIX) is currently at its lowest point in nearly two weeks, suggesting a surface-level calm in the broader market. However, underlying issues may still be present. Manny Shu, Head of Derivatives Market Intelligence for SIBO Global Markets, highlights a significant divergence between broad market volatility and individual stock volatility.

Divergence Between Index and Single Stock Volatility

• Key Point: The volatility in individual stocks (measured by VIX EQ) is significantly higher than that of the overall market index (VIX).
• Technical Detail: The spread between VIX EQ and VIX recently hit an all-time high.
• Explanation: This spread typically widens leading up to earnings season, as earnings reports are a major driver of single stock price movements. The current extent of this widening is considered notable and points to anxiety surrounding earnings and valuations, particularly for high-flying AI and tech stocks.
• Market Cap Weighting: The VIX EQ is market-cap weighted, meaning larger stocks like Apple and Amazon have a greater influence on its movement.
• Dispersion Theme: This year has seen a theme of high dispersion, where individual stocks are volatile but uncorrelated. This means that on any given day, some sectors might be up while others are down, leading to muted volatility at the index level.
• Exclusion of Meme Stocks: Volatility in "meme stocks" (e.g., Open Door) is not reflected in the VIX EQ, as this index primarily covers the top 80-90 S&P 500 stocks by market capitalization.

Investor Positioning and Hedging Demand

• Observation: There have been significant shifts in options market positioning, with a noticeable pickup in hedging demand over the past week.
• Investor Behavior: Investors are actively buying downside protection, particularly for the period leading up to year-end.
• Motivation: This hedging activity is driven by a desire to lock in year-to-date gains, anticipate potential risks, and capitalize on current stock performance by hedging at what may be perceived as favorable volatility levels.
• Shift in Sentiment: This indicates a shift in investor sentiment and positioning towards risk mitigation.

Correlation Between Bond and Equity Markets

• Bond Market Calm: The Treasury market has calmed down considerably, with yields decreasing in an orderly fashion.
• Bullish Tint: This calm is characterized by falling yields, suggesting a bullish sentiment in the bond market.
• Underlying Reasons: The decline in yields appears to be driven by positive factors rather than negative ones.
• Key Observation: Yields have fallen concurrently with rising inflation expectations.
• Market Interpretation: This suggests that the Federal Reserve is likely to prioritize concerns about a softening labor market over inflation risks and is expected to ease policy.
• Impact on Assets: Real rates have collapsed this year, which has been a significant factor underpinning positive performance across various asset classes. The loosening of financial conditions, which began even before the Fed started cutting rates, has been a key driver.

Options Pricing and Future Expectations

• Low Volatility Levels: The current low levels of the VIX imply that the absolute premium for options (both calls and puts) is low.
• Increased Option Activity: This has led to an uptick in options activity, as investors are using these low premiums to express their bearish or bullish views.
• SPY Options Pricing: For the S&P 500 ETF (SPY), options pricing one month out suggests a potential 3% move in either direction. The cost to buy at-the-money calls or puts is approximately 1.5% of the ETF's value.
• VIX One Day Index: The VIX One Day Index, which measures expected volatility over the next 24 hours, is currently around 80 basis points. This indicates that not much volatility is being priced in for upcoming macro data releases, such as the CPI report.
• Investor Strategy: Many investors are viewing this situation as an opportune time to hedge their positions.

Conclusion

While the broad SIBO Volatility Index (VIX) indicates a period of calm, a deeper analysis reveals significant underlying volatility in individual stocks. This divergence, coupled with increased hedging demand and a supportive fixed-income market environment, suggests that investors are actively managing risk and positioning for potential market movements. The current low cost of options premiums is also encouraging increased speculative and hedging activity. The market appears to be pricing in a Fed pivot and a focus on labor market weakness, even amidst rising inflation expectations.