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12 February 2018, 12:31 | Austin Hogan
Images Barcroft Media via Getty Images
While the S&P 500 recorded its biggest daily drop in over six years on Monday, the biggest eye-catcher has been the spike in volatility, with Wall Street's "fear gauge" hitting highs not seen since August 2015, when fears of a slowdown in China rattled global stock markets.
"With the CBOE SPX Volatility Index.VIX nearly tripling over the last three trading days mark-to-market profit and losses have been significant", said Ihor Dusaniwsky, head of research at S3 Partners.
Those strategies of selling volatility and buying risky assets have proved to be tremendously profitable in recent years.
The volatility spike caught a lot of people by surprise. The markets were placid and traders were sanguine.
The VIX closed yesterday at 39.94, its fourth "worst" day since the index was created in 1990. The S&P last corrected in January 2016.
A key measure of market volatility is surging in early trading Tuesday after a triple-digit percentage move the previous day. Global markets followed suit over the weekend and by Monday the USA stock market was in full retreat. So while Wall Street was devastated by a 508-point plunge in the Dow Jones industrials on October 19, 1987, a drop of that size today, while much smaller on a percentage basis, remains frightening. But during the market rout on Monday, it soared to 38.8, its highest level since August 2015, and rose by a record amount.
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Dusaniwsky said this could lead to higher volatility for XIV over the next few days as traders look to buy XIV to cover their short position. Once volatility started rising, these funds were forced to cover their short volatility positions.
Although the washout was violent, it was extremely quick, and stock markets have bounced more than 5 percent off Tuesday's lows.
It is important to put this correction in perspective. From its year-end close to the February 6 intra-day low, the market was down only 3 percent.
UBS analysts estimate that a USA equity decline of 7.4 percent, as seen over the last five working days, has historically been associated with a high yield spread widening of 75-80 basis points while the actual move has only been 21 basis points. Do all you can to understand what is happening as corrections unfold.
A strategy of betting against turbulence in equity markets.
Steven C. Merrell is an investment adviser and partner at Monterey Private Wealth, Inc., in Monterey.
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