We disseminate a note several mornings a week with 3 bulleted takeaways from derivatives-centric markets. The point is to hash out observed consensus views with our own to 1) Find asymmetric pressure points and 2) Generate non-consensus ideas. Below is this morning's note.
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Russell Factor Performance Update (R2K Vol Smash) – We’ve asked the question lately as to how much the tighter R2K relative volatility is due to the heavy, interest rate-centric industry weightings vs. something like R1K which has a heavy weighting to software, internet, computers? Some argue there is a structural change in the Russell 2000 volatility regime..
In the Implied/Realized heat map of our Russell Factor Performance table in the first visual below, we show where R2K ETF & factor IVOL trades on a percentile basis – low single digit percentile readings in an elevated equity volatility environment. If we look at a more top-down view of global macro Implied/Realized set-ups, the various Russell 2000 indices & factor ETFs have among the deepest IVOL DISCOUNT Z-Score Factor Readings in global macro – see the 2nd & 3rd charts below.
*NOTE* Many of the deepest IVOL DISCOUNT Z-Score Factor Readings are in U.S. equities right now as the difference in past vs. future expectations has widened to 30-40% on a 30-Day basis for most U.S. equity markets.
We’re not convinced of the “structural change” argument in the Russell 2000 volatility regime. It wasn’t long ago (last year) when R2K IVOL traded closer to long term averages vs. something like R1K IVOL – See the 4th chart below.
Right now, R2K and R1K 30-Day and 60-Day At-The-Money IVOL trades at the same level whereas the spread between At-The-Money IVOL in R2K and R1K IVOL over the last 10 years has averaged 6 points of volatility (which is a ~40% premium) on both those durations. We believe this set-up has much to do with the factors contributing to non-existent interest rate volatility, especially relative to the tech sector which has a heavy hand in the R1K. More on this below.
Rate-Linked Volatility Expectations – The conclusions shown in the charts below with regard to interest-rate volatility expectations are another version of the story above on Russell Index preferences and perceived risk…
We show the most divergent set-ups in long-term global macro volatility expectations in the charts below (6Mth & 12Mth contract expiries on the options where we’re extracting IVOL).
The conclusion would be that the muted rate volatility of the recent past is being extrapolated into the future as seen through a volatility lens.
The lowest long-term volatility expectations are in Credit/FI, Precious Metals, and rate-sensitive Equities like the Russell 2000.
Commodities (Least Skewed) - With the exception of a few Ag/Softs markets (Corn, Soybeans, Sugar), commodities are up m/m against a dollar that is slightly lower (-68bps for UUP). Everything linked to metals and energy is higher.
And the expectations read-through is that recent positive performance has created a directional shift as seen through the lens of volatility skew.
More specifically, the volatility surfaces that screen with the largest negative Z-Score Factor readings on skew are commodity markets. This ultimately means that buying downside puts in these markets is much cheaper relative to buying upside calls. The surface tilt has gotten more bullish. To see this flattening skew at the all-time low in precious metals implied volatility is extremely rare in any security.
We show both the TTM & 3Yr Z-Score factor analysis on both 25-Delta and 40-Delta skew. For context on the screen output in the four charts, commodities represent only 15% of the global macro tickers in the universe.
