After last week's Trump impeachment speculation sent domestic equity markets tumbling, the U.S. stock market has been up for three straight days. And in case you didn't know, the S&P 500 is within 0.3% of its all-time high. (See sector performance below.)
An Inside Look At Stock Market Volatility
What now? Well, there's a notable trend developing in equity markets. Investor expectations of future stock market volatility embedded in options markets, compared to historical or realized volatility, just fell off a cliff.
Without getting too technical, if fearful of a selloff in stocks, investors will bid up downside protection in options markets. This would imply investors expect future volatility above the actual volatility that's been realized in the past. That's called an implied volatility premium (i.e. future volatility expectations above historical volatility). On the flipside, an implied volatility discount is when investors don't expect a selloff and expectations are so low, historical volatility actually exceeds expectations of future volatility.
As you can see in the Chart of the Day below, implied volatility was high last week as speculation about a Trump impeachment rose. But expectations of future volatility got smashed over the past three days of stock market gains.
We're now seeing an implied volatility discount, relative to realized volatility. And it's acutally the first implied volatility discount of the year. In other words, says Hedgeye CEO Keith McCullough in today's Early Look, near the all-time highs for U.S. stocks either bulls are exhibiting a serious amount of complacency or bears have capitulated... or both.
Here's the step-by-step rundown from McCullough in today's Early Look:
- The S&P 500 had consistently high implied volatility PREMIUMS (vs. 30 day realized volatility)
- As market prices have scaled higher from every single immediate-term oversold low, PREMIUMS have burned off
- This morning the SP500 has an implied volatility DISCOUNT of -3.9% vs. 30-day realized
- So I’m definitely not buying the S&P 500 today.
There you have it. Keep measuring and mapping the rate of change in market expectations. That's how you beat consensus.
