Volatility Behavior During Federal Shutdowns Analyzed

Key Concepts

• Government Shutdowns
• Market Impact
• Volatility
• S&P 500
• Sector Performance (Airlines, Healthcare, Defense, Consumer Staples)
• Option Trading Strategies (Selling Puts)
• Mean Reversion

Historical Impact of Government Shutdowns on the Market

This discussion analyzes the historical impact of US government shutdowns on market performance and volatility, drawing insights from past events to predict potential outcomes of future shutdowns.

2019 Government Shutdown Analysis

• Market Movement: The speaker's initial recollection suggests the market moved sideways with a slight upward bias during the 2019 shutdown, ultimately closing higher than when the shutdown was announced.
• Volatility: The expectation is that volatility contracts after a shutdown, with the event being a "non-event" in terms of significant market disruption. However, there's an acknowledgment that initial uncertainty might lead to a slight upward bias at the start. The speaker humorously notes that this intuitive expectation of higher volatility might be incorrect.

General Observations from Past Shutdowns

• Longest Shutdown: The transcript refers to a recent, extended government shutdown, potentially the longest in US history. Initial estimates suggest billions in lost output and delayed spending.
• Market Rebound: In several past shutdowns, the market began to rebound before the shutdown officially ended.
• Sector Sensitivity:
  • Airlines: Consistently identified as the most volatile sector during government shutdowns. This is attributed to their consumer-facing nature and direct impact. Examples like AAL, UA, and Love (presumably Love Field) are mentioned as performing at or above their pre-shutdown price levels.
  • Healthcare, Defense Spending, Consumer Staples: These sectors are also noted as being affected by shutdowns.
  • Nvidia: Mentioned as an example of a company not significantly affected by government shutdowns.
• Market Context is Crucial: The overall market trend significantly influences the impact of a shutdown. A shutdown occurring during a strong bullish market is likely to have a less pronounced negative effect than one during a market downturn. The speaker emphasizes that looking at the "whole picture of the market" is essential.
• Equities vs. Volatility:
  • Equities: Despite the length of the most recent shutdown, equities remained in a tighter percentage range compared to previous shutdowns. The market has been described as "choppy" and going "nowhere."
  • Volatility: Volatility has shown more predictable patterns. It typically spikes at the beginning of a shutdown and then normalizes or "mean reverts" back to lower levels as the fear subsides. This is described as a "textbook example of spikes in volatility."

Specific Shutdown Examples and Data

• 2013 ACA Dispute:
  • The S&P 500 and various sectors showed a bid going into the end of the shutdown, with some volatility along the way.
  • A significant upward move was observed after the shutdown.
  • Airlines were a notable exception, showing larger market moves.
  • The chart axis represents percentage changes, with 1.05 indicating a 5% upside move.
• Border Funding Dispute (Trump Era):
  • Resulted in only very short-term drops for most equities.
  • Airlines were again the notable exception.
  • The market experienced a "little bit of a blip of volatility early on" and then "it was off to the races."
• Most Recent Shutdown (Lengthy):
  • Despite its length, the market stayed in a tighter percentage range than in previous examples.
  • Airlines again showed more volatility.
  • Volatility showed a spike, then came down, and then another spike more recently, which has also started to come down.
  • Poly Market Data: An 88% probability of the shutdown ending between Wednesday and Friday is cited from a "poly market."

Volatility and Option Trading Opportunities

• Predictable Volatility Spikes: Volatility spikes are predictable around government shutdowns.
• Mean Reversion: Volatility tends to mean revert back to a middle range after an initial spike.
• Option Premium: Puts become inflated during shutdowns, presenting opportunities for option traders.
• Selling Puts: Selling one-sided puts can be a beneficial strategy, especially for shorter-term shutdowns (e.g., two weeks), as the premium can be captured quickly.
• Frequency of Shutdowns: The increasing frequency of shutdowns makes it harder to take advantage of these opportunities, though they may accelerate the effectiveness of premium-selling strategies.

Conclusion and Takeaways

• Short-Term Effects: Government shutdowns typically exert bearish short-term effects, with certain industries being more sensitive.
• Airlines as Bellwethers: Airlines consistently demonstrate the most volatility during shutdowns.
• Market Resilience: Equities have shown resilience, often remaining in tight ranges despite the length of shutdowns.
• Volatility as an Opportunity: Volatility always shows significant action during shutdowns, offering opportunities for option traders, particularly in selling premium.
• "Calling the Shutdown": The speakers humorously claim to be the first to "call" the end of the most recent shutdown, likening it to calling election results.
• Status Quo: When the government shuts down and then reopens, it often returns to a "status quo" situation.

The discussion concludes by suggesting that in the event of future government shutdowns, traders should consider the potential for volatility and its implications for option strategies.