Inversion to The Mean

• Posted by Adam Warner
• on September 13th, 2009

Realized stock volatility is now offiially low, Bespoke has quantified it! (Hat tip: Abnormal Returns).

One of the most remarkable characteristics of the ’08/’09 market crash was the daily volatility that occurred.  On December 8th, the average absolute daily change of the S&P 500 over the last 50 days reached a record 4.02%!  With the entire US stock market gaining or losing 4% to 5% of its total value on a daily basis for two months, how did any of us stay sane? 

Since peaking late last year, however, the average daily change for the market has cratered.  As shown below, over the last 50 days, the average absolute daily change for the S&P 500 is now under 1% at 0.87%.  This is the lowest level since July 23rd of last year.  Markets fall much faster than they rise, so it’s no surprise that this number has gone down significantly as the S&P has risen 52% off of its lows.  But many investors also believe that the 2x and 3x long and short ETFs played a role in the huge price swings that we saw.  Going forward, we wonder what impact the banning of leveraged and inverse ETFs by brokerages will have on market volatility.

That .87% neatly translates into something like a 14 volatility, which is probably not surprising to you if you read here much in that I dedicate every other post to noting the pathetic lack of stock motion.

But what of these 2x and 3x Bogeymen Bespoke speaks of? Remember way back when, they were destroying America?

Now? Well they still exist, and we managed to have a monstrous rally anway. The only time you hear anyone mention them is in relation to a lawsuit. As in “the market imploded in Fall 2008, and all my -2x and -3x ETF’s went lower anyway.”

With the benefit of hindsight, it’s probably safe to say they work both ways. Both in terms of their effect on stock prices and volatility. Remember the “rebalance trade”? That appeared to add volatility as it moved the ETF further in the direction of the move that day. But on the flip side, the Inverse ETF’s become a de facto alternative to an actual put, and can lower demand for put protection and ergo lower implied volatility.

Whatever the case, you can see the avg. daily dollar volume here in SKF has plummeted. The stock has halved since May, and volume has as well.

At the end of the day, you can probably surmise that their mere existence hardly prevents market rallies.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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