Skew Helped VIX, Now What?

Over recent weeks, much has been made of the rise in listed equity options volumes, particularly those of call options. One can easily assert that we have been in a speculative market environment, and many of those speculators realized that call options could be a way to speculate on a rising market with a minimal cash outlay and defined risk. That speculative fervor reached a head during the GameStop (GME) frenzy of late January, but it had been building for several weeks prior. Yet something has been occurring much more quietly over recent sessions – call volumes have been dropping. What does this mean for volatility and markets in general?

Let’s take a quick look at the volume trends for options. Here is a graph of daily total US options volumes over the past year through yesterday:

Total US Options Daily Volume (Calls + Puts)

(Click on image to enlarge)

Total US Options Daily Volume (Calls + Puts)

Source: Bloomberg

We can see that the daily volume is somewhat erratic, so it is much more useful to focus on the 30-day moving average of the volume as displayed by the green line. We see that average peaking around the beginning of this month. The moving average has since trended lower, and if daily readings remain consistently below that average it will continue to decline.

When we compare the graph above to a similar graph of just call options volume, we can plainly see how the changes in volume have been largely the result of changes in call volumes:

US Call Option Daily Volume

(Click on image to enlarge)

US Call Option Daily Volume

Source: Bloomberg

Looking at the two graphs together, the message is quite clear. Call options have been driving the bus over the past few months.

In early February, we explained how speculative call activity was pushing up the CBOE Volatility Index (VIX). The index construction utilizes all options within a band around 30 days to expiration with a non-zero bid. That means that a wide range of out-of-the-money options have an effect on the pricing of VIX. Steeper skews have a positive effect on VIX.In other words, the more value that traders place upon protective puts and speculative calls, the higher the index reading (all things otherwise being equal). Over the past 30 days, despite some spikes late last month and early this month, we can see that VIX has trended marginally lower:

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