No one would argue that the past year has been normal for markets. (Or anything else, really.)
In the last 12 months, we’ve had multiple all time-highs AND the largest sell off since 2008.
The crazy part is, the stratospheric highs sandwich the giant sell-off. Weird.
Now, though, after 246 trading days, the VIX is finally back below 20. Check it out:
Sadly, we missed an even year by six days. (I’m a sucker for anniversaries!)
The sentiment I’m hearing from many people is, “Now what? What is my trading going to be like?
Well, know this … Despite the VIX being under 20, the way options trade now versus a year ago has fundamentally changed.
You see, individual equity option volume has exploded.
Last week was slow by recent standards and option volume on Friday was 43 MILLION contracts.
By comparison, a year ago, Option Clearing Corporation (OCC) volume was 26 million on a relatively busy day in the markets.
Why Is This Happening?
Interest in trading options has exploded because people are realizing the power of this financial product.
But what has changed fundamentally about volatility? The short answer is this:
When the underlying stock rallies, implied volatility on individual equities goes UP, instead of down.
While implied volatility for at the money options is approaching normalcy, out of the money options are expensive.
This is not going to change in equities anytime soon. And it will mean that VIX behavior on rallies, especially when led by a “meme,” will not be like it was in 2019.
Take a look at the formation of options on a name like Advanced Micro Devices (Ticker: AMD):
The chart above shows the plot points for implied vol by strike.
Traditionally, equities have high implied volatility for lower strikes and lower IV for higher strikes. The reason being, institutions have a natural tendency to “collar” stocks (buy a put and finance it by selling a call).
That trade seems to have gone away, replaced with speculative out of the money call buying.
Some of the strategies that used to work well in equities, like iron condors (a long and short put, a long and short call, four strike prices and the same expiration), are potentially permanently broken.
Index options on the other hand, I believe, are going to normalize and that means …
We could see a dramatic increase in volume on both S&P 500 Index (SPX) and VIX options in the coming weeks.
SPX skew is steep, but it does not have an upslope for out of the money calls, a pretty good sign it’s a viable hedging product.
As hedging costs come down (aka the falling VIX), we can expect traders to use more long put strategies.
I also expect for VIX volume to increase by 50% in the second half of 2021 as traders are able to engage in volatility hedging strategies.
This is EXTREMELY bullish Chicago Global Markets (Ticker: CBOE) stock.
Of the exchanges, the CBOE has the two products that expect to see the largest increase in volume over the rest of the year.
I’m a buyer of the CBOE June 100 calls for about 2.50.
The Option Pit VIX Light is Red, and volatility is likely to fall.
Your Only Option