A Market at the Crossroads
What a strangely fluctuant day it has been – gliding in strong, dipping in the middle, only to surge back in the final stretch.
Beneath the surface, peculiar phenomena are brewing; a set of foreboding signals eerily reminiscent of historic market peaks: escalating implied correlations, rising implied volatilities, and ascending prices.
This curious brew may well be a prelude to the looming, monumental week ahead, featuring colossal technology earnings, the Federal Reserve, the quarterly refunding announcement, and the jobs report.
Or perhaps, the market, like a weary traveler, is inching closer to the end of its long journey.
Implied Volatility and Market Exhaustion
Historically, a surge in implied volatility, coupled with rising prices, signifies that the market is approaching a point of exhaustion – a threshold awaiting its reckoning.
Recent data comparison revealed that the implied volatility for January 31 OPEX and February 16 OPEX remained relatively constant. However, both values were notably higher than the prior day’s figures.
Additionally, the skew of the implied volatility indicated a leftward ascent and a rightward descent, suggesting that the implied volatility for lower prices was surging at a faster rate compared to the implied volatility for rising prices. Overall, the implied volatility exhibited a universal escalation across strike prices.
Implications of Implied Correlation Index
An added cause for concern lay in the surge in the implied correlation index for durations of 1, 3, 9, and 12 months.
It’s worth recalling that in July, a similar increase in these indexes heralded the onset of a market peak a few days later. While isolated upticks do not essentially constitute a trend, they certainly warrant vigilant supervision.
Effect of Individual Stock Implied Volatility
Akin to the events in July, the implied volatility of MAG7 climbed notably prior to earnings announcements. Subsequently, post-earnings, the implied volatility reversed course abruptly, akin to Tesla’s performance yesterday.
This downturn in individual stock implied volatilities is detrimental to the dispersion trade. It undermines the viability of shorting volatility in the S&P 500. Typically, a long volatility hedge, which is the stocks in the index, is essential to short vol in the S&P 500. Hence, if the implied volatility plummets post-earnings, the trade becomes untenable.
The Influence of Daily Market Dynamics
Meanwhile, the market’s daily narrative echoes a recurring theme. Nvidia’s role in buoying the entire S&P 500 remains pivotal, fomenting a daily gamma squeeze, as evidenced by the escalating implied volatility and call volumes.