What’s Behind the Volatility in Equities?

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For most of the last five years, equity markets have been on a steady upward trend. 2013 was the best year for the Dow Jones Industrial Average in 18 years, and the best in 16 for the S&P 500. 2014 has seen several new record highs for both indexes. So the pullback at the end of July, the biggest in two years for the S&P, was a trend reversal.

To illustrate how quickly things changed, the Volatility Index (VIX) which measures equity options volatility on the S&P 500, recorded its lowest level of the year on July 3 while the markets were still climbing to record-highs. By August 1, the VIX had reached its highest point since Q1.  In addition, CME Group’s equity index options complex — which includes the S&P 500, Dow Jones and NASDAQ — saw record volumes on back-to-back days July 31 and August 1. Market watchers had anticipated a correction in equities, but could the latest retreat be something more significant?  To get an idea, we talked with Anthony Crudele, founder of E-Mini Exchange, a futures education firm specializing in the E-Mini S&P 500 and E-Mini NASDAQ, among other markets.

 

Last week was a big week for economic news, including a strong  second quarter GDP release and steady employment numbers. How did this impact equity index futures overall?

The impact of the economic news on the equities markets was that good news doesn’t necessarily mean that the market rallies.  Throughout this bull market run, the dynamics within the rally have been two things; climbing a wall of worry and a Fed that has been providing liquidity.  The Fed providing liquidity gave the bulls confidence to step in and take risk in the stock market.  That in my opinion is what drove the rally and now that the wall of worry may be gone along with the Fed pumping liquidity, what does that mean for the market?  That uncertainty is what’s currently driving the wild swings in the equity markets.  If you compound that uncertainty with geopolitical risks that we have seen surface as of late, you now have an S&P that is very unsettled.

 

CME Group saw an Equity Index Options record of 1,159,176 contracts, beating the previous record on 7/31 of 1,080,307.  What’s driving the activity in equity options lately?

It’s a couple of things.  Equity index options trading has been growing over the past few years, so when we see spikes in volatility like we did last week, seeing a record number of volume in equity index options is not a surprise to me.  I also believe  that the market uncertainty is causing traders to use options for protection of their positions and also a good way to make a new bet on the next move in the market.  Record volume days in equity options continues to be a trend due to its growth in popularity and because of the heightened uncertainty in the markets.

 

The VIX saw a spike to end July.

 

Is this  a sign that volatility is back in the equity markets, or was this a one or two-day blip? 

Impossible to say for sure, but in my opinion this is a start of more volatility to come.  Uncertainty is the word that I hear from almost every single trader I know and when that is the most common word that you hear, expect more volatility to come.

 

Are there events equity market participants should look to that may drive further activity, or are we looking at a classic correction?

There are a couple things that I will be watching.  The obvious one is geopolitical headlines.  They don’t matter until they matter.  The current headlines that we are seeing do not seem matter that much (at the moment), but at any given time the market may start to take notice.  When we start to see high volume sell offs due to geopolitical headlines, then we know they matter and look out for a possibility of selling to escalate due some technical breakdowns on the charts.

The next event I would watch is the bond market and how they react to the data or Fed comments.  If the Bond market starts to see a rapid rise in rates, the Equity market looks at that action very carefully.  If rates start to rise quickly, that could be an indication that the Fed could soon be raising rates and how equities react to that will very important.  If rates are headed higher and S&P is headed lower, that could be an indication of a new trend in the markets.

 

About the Author

Evan Peterson is director of corporate marketing at CME Group and managing editor of OpenMarkets.

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