foxex: Second Wave?

Chart Advisor | Focus on the Price

Thursday, June 18, 2020

1. Option pricing disparity on benchmark index

2. Nasdaq index does not reflect volatility pricing

3. Oil prices forecast no new demand interruption

[Programming Note: Our offices will be closed tomorrow to observe Juneteenth, and we will be suspending our newsletters for the day. We'll be back with you on Monday. Juneteenth commemorates June 19, 1865 when Texas became the final U.S. State to formally proclaim its enslaved people free, thus ending the injustice of slavery entirely in the United States. This came following the end of the U.S. Civil War which was fought to end the institution.]

Market Moves

With the exception of oil prices, all assets today traded in a tight range, closing nearly unchanged. This created an important divergence between the CBOE Volatility Index (VIX) and the S&P 500 (SPX) that implies option traders may be bracing for the effects of a second wave of COVID-19 infections. However, not all benchmarks seem to be in agreement with this forecast. The difference between historical volatility and implied volatility may actually be forecasting the opposite outcome.

The chart below details the divergence between the two indexes that has appeared over the last six sessions. Usually the VIX moves in a generalized mirror image to SPX. The relative highs and lows will often occur on, or near, the same day. As the chart below displays, the relative low point of the past three sessions does not correspond with the slightly higher high point for this week on the S&P 500.

What that means is that option sellers are holding on to slightly elevated prices for the options they make available. This was similar to the dynamic that lasted for nearly a month between last December and early January. In hindsight it seems that option sellers were able to forecast the possibility of the pandemic outbreak before it became widespread outside China.

If option market makers are demanding higher prices now, it may be that they fear the risk from a second wave of the pandemic outbreak. However, if that were true, it might also be true that we should see evidence of this fear in other benchmark indexes.

Nasdaq Index Does Not Reflect Volatility Pricing
Comparing the price action on Invesco's Nasdaq 100 ETF (QQQ) with the Average True Range (ATR) of its moves gives us a good look at the historical volatility of large technology companies. If a greater risk had become evident, then the trading range of this index should have remained larger over the past three days.

As the chart below details, the ATR hit its low point on the tenth of June. As trading ranges exploded for two days last week and one day this week, the ATR made a visible spike. Yet the ATR on this chart is trending lower as traders seem to doubt that the large range on this ETF will continue. So although three sessions were larger ranges, the most recent three were comparatively muted. The unavoidable implication is that buyers don't really fear a second wave, because they are not creating larger trading ranges for the day by rushing to exit positions.

[READER SURVEY: We are running a two-week survey of our U.S.-based readers to gauge your sentiment and see what moves, if any, you have been making with your money given the market recovery. We'll share the results, as always, and we thank you for your time and participation.]

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Oil Prices Forecast No New Demand Interruption

The story for oil prices (USOIL) provides even more contradiction to the fears of a second wave outbreak. The chart below details how the Oil Volatility Index (OVX) has been steadily falling over the past month as the price of oil has been on the rise. Considering that the commodity price rose over three percent today, it will seem clear to chart watchers that oil buyers are telegraphing their expectation of no significant interruption in demand over the weeks ahead.

How can such divergent price actions be reconciled? One possible explanation could be that traders have priced in what they think the effect of the second wave will be, even if it does come. If that were an accurate assessment of investor sentiment right now, then it would imply that investors, on balance, remain quite optimistic.

The Bottom Line

Investors and traders kept indexes for nearly all asset classes in a tight range for the day. Even though the VIX seems to be holding on to a bit of risk premium, the price action in the market-leading Nasdaq 100 benchmark does not. Oil price dynamics seem to agree with the Nasdaq as investors signal that they see no new impact from additional pandemic outbreaks.