Is Volatility Going To Continue To Plummet This Summer?

| July 26, 2019 | 0 Comments

volatilityJuly is traditionally a very slow month for the financial markets. Not only is it the prime vacation month for families (most kids go back to school in August), but there’s also the July 4th holiday week. Generally speaking, investors and traders are often far away from the markets at this time of year.

Even in a year like this one, with a lot of potential market-moving headlines, July has remained slow to downright boring. The China trade war, saber-rattling with Iran, and questions over Fed interest policy have barely had any impact on investor sentiment.

Stocks have reached all-time highs despite the potential for a global recession around the corner. Part of this may be due to the Fed seemingly planning on cutting rates at the end of the month. Fed officials have made it clear they want to get ahead of any potential economic slowdown. It’s certainly given a boost to stocks and destroyed what was left of market volatility.

The VIX, the Cboe’s S&P 500 Volatility Index, has gotten hammered in recent weeks. The market’s leading gauge of investor fear, the VIX spent much of the year around 15 and higher. After several weeks with no action, the index is down to nearly 12.5 – and close to last years lows.

VIX Chart

Popular volatility ETFs/ETNs are also hitting new lows (as they are all currently tied to the VIX). The most popular product in this space is the iPath S&P 500 VXX Short-Term Futures ETN (VXX), which tracks the first two futures months in the VIX.

VXX was trading around $32.50 at the start of June. Not even two months later, it’s down near $22. Now, it’s not necessarily unusual for volatility to drop to very low levels. It is a bit surprising at just how fast it has fallen – especially considering the headline risk.

VXX Chart

Nevertheless, some options traders feel the VXX could continue dropping. A significant trader just purchased 20,000 August 16th 19.5 puts in VXX, with the share price at $22.50. The trader only paid 12 cents for the puts, which cost $240,000 overall.

Breakeven for this trade is $19.38, and anything below that generates $2 million in profit per dollar. The risk is only $240,000 or the premium from the trade. Generally speaking, this is a low-risk trade due to the low amount of premium of the option.

It seems unlikely that volatility will continue to fall to the extent where 19.5 puts make money in the next month. Nothing would have to happen from a headline perspective over that period, which would be a real surprise, particularly with the Fed meeting coming up in a week.

Perhaps this is someone who has taken a long volatility position elsewhere and is looking to hedge cheaply. Or, maybe it is just a flier that volatility is going nowhere for a large chunk of the remaining summer season.

It’s not the sort of trade I would recommend, but it’s also not taking a significant risk to put on this position.

 

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Category: Options Volatility Watch

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Jay Soloff is an options analyst with Investors Alley.

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