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A Brief Primer on Volatility: Is the Nasdaq Overbought?

A Brief Primer on Volatility: Is the Nasdaq Overbought? - rollercoaster 22

Is it time to book gains in U.S. equities?


It's worth pondering. The Nasdaq is up 9.6% and +5.3% from its November and December lows. The real money in macro markets is obviously made by selling things that are overbought and buying things that are oversold. On that score, checking in on the investor's expectations of future volatility in equity markets is deeply instructive. It provides a nice read-through on consensus.



  • Realized Volatility = Historical Volatility (the market fluctuation of an asset over a given time period)
  • Implied Volatility = Future Volatility (the volatility that investors expect in the future based on current options market positioning)


Applying these principles helps understand whether prevailing investor sentiment is one of complacency or an outlook that is overly pessimistic. 


Basically, investors fearful of future fluctuations pay up for downside protection. In this instance, you would see higher implied volatility versus realized volatility. This is called the volatility premium (where implied volatility exceeds realized volatility). Conversely, a volatility discount happens when implied (future) volatility is below realized (historical) volatility.

How to Trade when the premium or discount stretches to extremes 

This is typically a kneejerk reaction that suggests a move is most likely overdone. Consider the Chart of the Day below. It shows implied versus realized volatility for the Nasdaq over the past sixteen months.


As you can see, before the presidential election in November, investors were uncertain about a Clinton or Trump win and piled into options contracts that offered downside protection. The implied volatility premium stretched to almost 70% above realized. 


But then, in the wake of Trump's win, exhuberance set in. Expectations of future volatility started moving down and the volatility premium normalized. (Note: This is why we got bullish on the Nasdaq towards the end of November).


What happened? Formerly fearful investors capitulated and bought stocks. Since Election Day, the Nasdaq is up +7.1%. The volatility premium is now +9.1% versus the 3-month average premium of +15.3%.


A Brief Primer on Volatility: Is the Nasdaq Overbought? - 01.10.17 El Chart

Interpreting Investor's Volatility Expectations

Here are three questions (and our answers) to think about from Hedgeye CEO Keith McCullough (in today's Early Look):


  1. Do you consider rising implied volatility premiums (i.e. pre-Election Day rise in Nasdaq options contracts) a bullish or bearish indicator? I think rising implied volatility premiums are encouraging me to believe that being bullish is not consensus
  2. Do you consider falling implied volatility premiums (i.e. post-Election Day move in Nasdaq options contracts) a bullish or bearish indicator? I think falling implied volatility premiums mean I’m getting paid on the long side and should book some gains
  3. And when you flip to implied volatility discounts, do you think rates of change matter as well? I think that when implied volatility falls and trades at a relative discount, I have no business calling my longs contrarian 


In other words, as investors get more fearful of future volatility, at the right level, that's when you get long. As implied volatility falls and formerly skittish investors capitulate (i.e. pile into equities), you cover your long position and book gains. When volatility is at a discount, investor complacency has set in once again (so don't get long, stay out of the way!). 

What to do now: The Current Setup in U.S. Equities

At the current volatility premium of +9.1% on the Nasdaq, here's some advice on specific levels from Hedgeye CEO Keith McCullough:


"I’d much rather buy the Nasdaq when implied volatility premiums (on 30-60 day durations) are running +15-30% than here."


There you have it. Book gains in the Nasdaq and wait for a consensus freak-out once again to get long. That’s what makes the S&P 500 a more interesting “BUY” now on pullbacks. Its 30 and 60 day implied volatility premiums are +16-24%.


REPLAY | Special Free Edition of The Macro Show with Hedgeye CEO Keith McCullough

REPLAY | Special Free Edition of The Macro Show with Hedgeye CEO Keith McCullough - km3.1.16

Did you miss this special (free) edition of The Macro Show? No Worries ... watch the replay here!


Why Exact Sciences Has More Upside (Even Though It’s Up 20% Today)

Why Exact Sciences Has More Upside (Even Though It’s Up 20% Today) - thumbnail Healthcare Exact Sciences 1 9 16 TT NO TEXT

“We think the marketing opportunity here and execution opportunity here could be big, given that [Cologuard] tests are pretty good and we’ve got a lot of good feedback from physicians,” Tobin says.

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Cartoon of the Day: All-Time High

Cartoon of the Day: All-Time High - Nasdaq cartoon 01.09.2017


The Nasdaq hit an all-time closing high today. Getting long the Nasdaq is also a great way to play U.S. economic growth accelerating.



Click here to receive our daily cartoon for free.

ICYMI: Brexit Fears Overdone, Buy British Pound


"We're leaving. We're coming out. We're not going to be a member of the EU any longer."

–U.K. Prime Minister Theresa May


Prime Minister May made the comment above in an interview on Sunday, dismissing entirely the possibility that the UK might "keep bits of membership" to the European Union. The British Pound was down more than -1% on that news this morning. Investors feared  the repercussions of a long, drawn-out “hard Brexit” from the European Union.


We believe those fears are overdone.


We think this is an opportunity to get long the British Pound (FXB). We suggest investors buy the pound on pullbacks, like today, and sell on days when the pound rises in value. The immediate-term risk range (our proprietary ranges that change daily) today is $1.21 – 1.24. Essentially, when the pound hits the low-end you buy and at the top-end you sell. Simple.


Another reason to buy the pound? Wall Street consensus is still short.


As you can see in the video above, institutional investors are net short pounds by -60,109 contracts (futures and options), according to data from the CFTC. Just three months ago, consensus was short pounds by -90,000 contracts before getting squeezed out of those positions. The pound rose 5% from mid-October to the December highs of $1.27. Wall Street was forced to cover shorts.


As we pointed out recently, the British economy grew +2.2% year-over-year growth in the third quarter. That was even better than the USA’s +1.7% year-over-year growth rate. Despite Brexit fear-mongering, we think the U.K. economy will continue to grow and Wall Street capitulates (once again) on these short positions. 


Will Trump Be More JFK or Eisenhower On Foreign Policy?

Will Trump Be More JFK or Eisenhower On Foreign Policy? - trump eis or jfk

Hedgeye National Security analyst LTG Dan Christman USA Ret. dissects the "grand vision" that will shape President-elect Donald Trump's foreign policy agenda. On this grand vision, "two presidential narratives have competed for over half a century," Christman writes, Eisenhower and Kennedy. Christman thinks Trump is more like Eisenhower. Here's why.

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.37%
  • SHORT SIGNALS 78.32%