Daily Options Report

My friend Ryan Renicker has moved from New Edge over to Ticonderoga Securities. Here are some of his thoughts on volatility going forward.

Despite a persisting decline in equity volatility during the past year, the option market appears to be continuing to price in elevated risk expectations (implied volatility) ahead of CQ4 earnings season.

In fact, I found only 1 stock (including ETFs) out of the 120 or so names included in my universe which currently has relatively low risk expectations priced into its options – the SPDR Gold Trust (GLD).

To me, this heightened level of anxiety to a large extent illustrates the lack of clarity investors have on the magnitude, direction and sustainability of the recovery from the recent recession.

Despite this, I anticipate a sideways market for the majority of this year (+/- 10% range) and the S&P500 SPDR (SPY) trading at about 130 by year end (15% return for 2010).

Thus, I anticipate an ongoing decline in volatility for the major equity indices and a return to a lower correlation trading environment.

I basically agree with all these points. Well, except the SPY call, I don't really think about longer term predictions. What we have now, and have had for at least 6 month's in most spots, is declining options volatility that just can't keep up with the utter implosion in realized volatility. A trader on stocktwits forwarded me a chart and asked if the VIX was bottoming. My under 140 character response was that I don't read that much into VIX charts, as it's a statistic and the concept of support/resistence doesn't really apply as we know it in regular stocks. There's no natural buyer or seller at a given level, best you can say is there's modest psychological factors. But that being said, would guess the VIX is not going much lower just yet. It tends to hover at a level for a while before ticking lower, sort of in a stair step fashion. And I suspect it just decided it was long enough holding 20 given that realized volatility in SPX never shows a pulse.

But longer term? There's no particular reason to say it won't keep drifting. Like Ryan says, pretty much everything is overpriced relative to how it's actually moving. As the VIX drips under 20, it's still not much under long-term average levels.

As to the correlation, that refers to how stocks move relative to each other. 2009 was a relatively high correlation market as most everything rallied. As such, owning a basket of individual stock options did not do well compared to owning index options. If correlation decreases, you're better served pickiing names. And I suspect he's right on that.