Mandy Xu, Head of Derivative Market Intelligence for CBOE, joins Patrick and Kevin to discuss volatility, divergence between rates and equity volatility, the new dispersion index, and top things to watch in the market. They also analyze the dollar's potential for a bounce back, crude oil price action, emerging markets performance, credit worthiness, trading options on shorter timeframes, and banter about cold weather in different locations.
The DSPX index helps investors understand the degree of risk within the S&P 500 index and provides valuable insights into market conditions.
The volatility risk premium can create opportunities for option sellers to capitalize on the overpricing of implied volatility compared to what is actually realized.
Understanding dispersion and correlation can provide valuable insights into the risk landscape and the potential for active investing strategies.
When crowded trades unwind, it can result in increased volatility and potential losses.
The Fed faces a difficult decision in determining the best course of action to balance inflation concerns while supporting economic growth.
Deep dives
The DSPX Index: A Measure of Implied Dispersion in the Market
The DSPX index, or SIBO S&P 500 dispersion index, measures the expected dispersion or volatility of individual stocks within the S&P 500 index relative to each other. It is an implied dispersion measure, similar to the VIX, which measures the expected volatility of the S&P 500 index itself. The DSPX value represents the one standard deviation cross-sectional return of the stocks within the S&P 500. High dispersion levels indicate greater potential for stock picking alpha and active investing, while low dispersion suggests a more passive strategy may be appropriate. The DSPX index helps investors understand the degree of risk within the S&P 500 index and provides valuable insights into market conditions.
Understanding Dispersion and Volatility Risk Premium
Dispersion refers to the volatility of individual stock returns relative to each other within a particular index. It is a measure of potential stock picking alpha and active investing opportunities. The volatility risk premium is the difference between implied volatility and realized volatility. It represents the market's tendency to overestimate future volatility. Low volatility does not necessarily mean cheap volatility, and it is important to differentiate between implied and realized measures of volatility. The volatility risk premium can create opportunities for option sellers to capitalize on the overpricing of implied volatility compared to what is actually realized.
The Relationship between Dispersion and Correlation
Dispersion and correlation are not always inversely correlated. In some market environments, both dispersion and correlation can rise together, while in other situations, they may move in opposite directions. Dispersion measures the volatility of stock returns relative to each other, while correlation measures the degree of co-movement between stocks. Both are measures of risk and can help investors understand market conditions and investment opportunities. Understanding dispersion and correlation can provide valuable insights into the risk landscape and the potential for active investing strategies.
The DSPX Index, Desk Positioning, and Crowded Trades
The DSPX index is designed to complement the VIX by providing insights into dispersion and active stock picking opportunities within the S&P 500 index. Trading desks are typically long single-stock volatilities and short index volatilities. They aim to capture alpha by actively managing positions and taking advantage of relative value opportunities. However, the DSPX index suggests that crowded trades, where many traders have similar positions, can lead to potential risks. When crowded trades unwind, it can result in increased volatility and potential losses.
The Fed's Dilemma: Cutting Rates to Slow Inflation?
One perspective suggests that the Fed cutting rates too early could result in accelerated inflation. However, another view argues that rate cuts can actually help slow inflation by reducing debt spending and supporting smaller businesses. It may also help offset the fiscal spending driven by the inflation reduction act. Ultimately, the Fed faces a difficult decision in determining the best course of action to balance inflation concerns while supporting economic growth.
The Implications of Fed Rate Cuts on Inflation and Economic Growth
The debate over whether the Fed should cut interest rates centers around its potential impact on inflation and economic growth. While one argument suggests that rate cuts could lead to increased inflation due to added money in the private sector from government spending, an opposing view suggests that rate cuts can actually help slow inflation by reducing debt spending. Additionally, rate cuts could support smaller businesses and employment, particularly as the corporate refinancing matures and fiscal spending continues under the inflation reduction act.
The Dual Objectives of the Fed: Inflation Control and Economic Stability
The Fed faces a complex decision as it contemplates rate cuts. While one concern is the risk of early rate cuts leading to accelerated inflation, there is also the potential benefit of rate cuts in reducing inflation through the curbing of debt spending. Furthermore, rate cuts could provide support to smaller businesses and employment, addressing challenges in corporate refinancing and the sustained fiscal spending associated with the inflation reduction act. Balancing inflation control and economic stability remains a key challenge for the Fed.
The US departure from the Bretton Woods agreement and its impact on gold
In May 1971, the US departed from the Bretton Woods agreement and closed the gold exchange window, causing gold prices to surge. However, the anticipated surge in demand from American investors for gold did not materialize, leading to a significant decline in gold prices by August 1976.
The potential for a gold breakout and opportunities in gold miners
Gold is attempting to break out to an all-time new high and presents an opportunity for a significant breakout in the coming years. Central banks' increasing purchases of gold, driven by the risk of holding US treasuries, are seen as a bullish factor. Despite the lack of participation from gold miners, there is a belief that when gold starts to shine again, miners will make profits and attract investment. Additionally, the decline in input costs, such as energy, further supports the potential for higher profitability in the gold mining sector.
This week Patrick and Kevin welcome Head of Derivative Market Intelligence for CBOE, Mandy Xu. Kevin and Mandy take a deep dive in to all things volatility. They cover the persistent bid in the MOVE Index, the incredible flipping of IWM skew and why the volume in 0DTEs is not as worrisome as it might appear.
