2020 was an extreme year. As individuals, governments, and industries cope with the direct and indirect effects of Covid-1, global securities markets are gearing up for a high-participation in the US presidential election that may be dramatically different from its recent predecessors.
Excited by the unprecedented volatility of February and March, what can investors, asset managers and traders expect in the last months of 2020?
Indicators offer an effective way of measuring the market and listed index-based derivatives can provide the basis for analysis in the form of market price, underlying volatility, open position and alternative flow sentiment.
Broad-based index options are commonly used by portfolio managers and traders for precise adjustment of risk and exposure. Market-makers and liquidity suppliers play a key role in this process, risking capital and adjusting prices in anticipation of supply, demand and future market behavior. In the United States, liquidity is highest in the S&P 500 Index Options (SPX) on Cboe on, with about 1.2 million contracts, or $ 5 billion in premiums, changing hands on average – three times as much on busy days.
The unique features of the SPX option, combined with the basic features of the listed options, provide valuable insights into expectations and position ahead of important events such as the 2020 US presidential election.
Prices and volatility
In theory, an accurate assessment of options is a work of intrinsic value, expiration time, strikes, interest rates, dividends, and volatility. Although all inputs are subject to some degree of uncertainty, volatility gets the most attention in practice because a serious miscalculation of volatility can lead to unexpected trading results.
Looking at alternative prices, the mid-market level of underlying volatility at any given time indicates the market expectation of daily returns for the alternative period. Many alternative traders “think” of volatility rather than price terms, which enables a simple comparison between product and time.
The underlying volatility of the Interpolated A-The-Money SPX options on 1 September 2020 and 1 September 2016 shows dramatically different expectations. In 2016, 90-day options, including the November 8 election, were trading with 13% underlying volatility, about 2 points higher than short-term options. Although a slight selective “push” is visible in the data, 2016 option prices reflect a relatively smooth term structure of perfect volatility, rising 17% over a two-year period.
This year, although the short-term underlying volatility is close to 20%, the uncertainty surrounding the election period is significantly higher with the volatility close to 24%. The word structure displays a long “hump”, showing a further 90 days over a 180-day period or the end of February 2021, which suggests a longer period of price variation than in 2016.
SPX ATM Underlying Instability: 1 September 2016 vs. 1 September 2020
The calculation of forward volatility from this underlying volatility gives another perspective on market expectations, which detaches the expected volatility for a certain period of time in the future. For 2020, the underlying volatility ahead of the -0 to -0 days stands at a high point near 29%, which has returned to the 23% range over the next three months. In contrast, the instability of the 2011 forward was relatively flat in the second quarter of 201 forward, close to the well% of the surprisingly less perceptible instability of 2017 2017.
SPX ATM Forward Instability
SPX implemented volatility (20d) and index level
Based on the price of the current SPX option, the market trajectory is expected to be even larger towards the fall, with November election day approaching, and will continue for a few months later. In terms of price, the shift from the current 20% volatility to 29% would be perceived as normal (one value deviation) as daily rice ranges from 1.25% to 1.8%.
All SPX options are cleared by the Trade Option Clearing Corporation (OCC), which publishes a net arrears agreement for each option listed on a daily basis. Positions are opened and adjusted over time, open interests change, providing transparency in the holding of market participants. Open interest can be seen in the underlying, term and strike stages. At the highest level, the overall SPX open interest on September 1 stood close to 14 million contracts and represented a conceptual value of $ 4.9 trillion.
Focusing on expired contracts after the elections of 2001 and 2020, the overall configuration shows a similarity, with the amount of contracts in 2020 being 1% higher than in 2016 and the largest positions held in December when year-end hedges are common. Compared to 201 to, the SPX Open Interest for 2020 is significantly higher in terms of January and March, which extends to 2021 in line with positioning for an unstable period.
SPX option open interest
In conventional terms, post-election open interest, with a total level of close to ২০ 20 billion, above%, lags behind the 2. %% growth and reflects greater use of the contract at this time.
SPX Option Interest: Fictitious price
Strike-level open interest provides close monitoring of timing and market level managers, as well as imaginary quantities, subject to the understanding that multi-leg spreads, which make up about 70% of the SPX option volume, must be considered.
SPX Open Interest by Strike, 1 September 2020 – OI> 5k, Selected Terms
As of September 1, more than 5,000 contract positions are in broad negative strikes, with large positions near 160,000 contracts at 2500 and 3000 strikes, representing 30% and 15% downside exposure, respectively, 7 days from the S&P 500 index closing value.
Alternative sequence flows can give a different perspective on market dynamics. At the basic level, order flow analysis makes trading activity relevant so that the buyer or seller can identify whether to start trading, such as market side modeling, comparing theoretical values with trade prices and the effects of price and underlying volatility. With additional analysis to explain multi-leg trades and algorithmic execution, order flow analysis helps market participants identify focus and expectations for the period of interest.
The SPX order flow in post-election contracts over the past three months has been influenced by the son of December, which is not uncommon for hedge portfolios due to the popularity of the product. The most active deal, put December 2500, is one of the largest blocks of open interest today, providing a hedge 29% spot down.
Most active stock options, overall, SPX, June 1 to September 1, 2020
A sample of the largest direct trades with an expiration date after selection shows a permanent bias, consistent with the long-term put / call ratio of the product near 3: 2. One of the biggest blocks opened in June, when 10,000 12/31 expired 2500 strike putts were bought for 90 90, with a িয়াম 90 million premium trade strike in 20% of the money that could hedge a ভ 3.1 billion national value.
Among the complex orders, Sept. 1 led to a spread caller making seven of the top 10 non-complex trades in the gap, offering a potential profit of 5 225 million in the event of a move from 20% to 2850 in return for the reverse risk of a 3800 (+ 7%) strike.
While accurate forecasts of market behavior remain elusive, index options provide a data-driven window to the combined expectations of traders, portfolio managers and investors. Based on the September 1 data, traders expect that ola November approaches will increase volatility and then have a longer period of stability than most of the last decade. Although the priority of negative strikes is not uncommon, the hypothetical value associated with the expiration position after the election is significantly higher than in the previous cycle. It reflects a combination of year-end hedges and long-term positions that protect portfolios and reflect the views of managers.
This is the second installment in a series from the Index Industry Association (IIA). Cboe is a member of the IIA and supports the association’s goal of independence, transparency and competitiveness of index providers.
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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.
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