While the global equity rally looked poised to cool in the face of new virus lockdowns from “sea to shining sea” in America and the still tenuous situation in Europe, behind-the-scenes flow dynamics are still generally supportive for domestic stocks.
“The trade higher into this week’s Op-Ex cycle with supportive Vanna- and Charm- flows [is] holding the line against increasing monetization of client longs and choppier price action,” Nomura’s Charlie McElligott wrote Tuesday.
He also flagged the vol-dampening effect of the “to and fro” rotations engendered by vaccine news and the subsequent fading of inoculation euphoria. That dispersion “help[s] cancel index level vol-shock risk,” McElligott wrote.
Read more: From ‘We’re All Gonna Die’ To 15-Sigma ‘Hope’ Shocks (And Beyond)
Worth noting in this context — and I don’t want to get sidetracked, so I’ll just mention it in passing — is a brief piece from Bloomberg’s Cameron Crise who, on Monday, noted that average 10-day single stock vol in the S&P rose from 37% at the end of last month to 54% now. At the same time, average 10-day correlation dropped to 0.09.
“Usually, we associate elevated volatility with a higher correlation. How unusual is this confluence of high vol and low correlation?,” Crise asked, before answering his own question. “Very. There have only been 78 days prior to last Thursday when the average 10-day vol was above 50% but the average correlation was below 10%.” Again, I mention that in passing given the tangential connection to the dispersion discussion. If you’re so inclined, you can look up Crise’s piece on the Bloomberg for more.
Getting back to McElligott, he notes that after Op-Ex, there’s scope for bigger swings as the vaunted “pin” loses some of its power. “The Dealer ‘long $Gamma’ profile is likely to drop significantly, particularly in light of the ‘extremes’ in $Delta which likely sees profit-taking off the back of the move higher in Spot,” he said Tuesday.
Notably, he also points to “a significant expansion of calendar implied vol [and] ongoing steepening in term structure.” At the front-end, things are compressing now that the election event risk has passed and into what is quickly becoming a consensus view that the Fed will use the December FOMC meeting to announce WAM extension, while the ECB is almost guaranteed to authorize more dry powder for PEPP. (Don’t get bogged down in the acronyms — it’s just maturity extension on the Fed’s existing monthly QE to make the purchases more “stimulative” and the ECB topping up its pandemic asset purchase program.)
That front-end softening is set against bid back-months, McElligott notes, attributing that to “COVID closure potentials, economic contraction risks thereafter in the absence of stimulus, and the chance that we could still have a ‘tail-event’ in the form of the Georgia runoffs.” Those runoffs, if won by Democrats, would make the “blue sweep” a reality overnight, forcing the market to suddenly price back in tax hikes and a $2 trillion+ stimulus package as foregone conclusions, rather than non-starters in the face of a GOP Senate firewall. That is not a likely scenario, but it’s possible.
Is this “bad” or “scary” (to lapse into colloquialisms)? In a word, no. Because, as Charlie points out, in addition to capturing the simple rolling-out of existing positions, vol calendar expansion means “investors continue to understand and respect the potential for more shocks.”
That’s just another way of saying that despite what you might be inclined to think based on where the benchmarks are perched, rampant complacency isn’t a problem for now.
