Volatility in the Crosshairs

With the instability of the new White House administration, North Korea launching missiles all over the Pacific Ocean and an unsettled global economic picture, you would think market participants are enjoying substantial volatility in all markets. The opposite, however, seems to be true.  Volatility is near historic lows in the U.S. stock market.  Moreover, the lack of volatility is not confined to equities—it has spread across asset classes to gold, treasuries, and crude oil as measured by WTI.   

Figure 1 below shows volatility percentile rankings for some major options on futures contracts. Take, for example, E-mini S&P 500 futures options. At the Money (ATM) volatility is currently 7.57%. This “ranks” it in the third percentile…i.e., volatility is higher 97% of the time.  Low volatility usually brings low options premiums. Higher volatility generally translates into higher premiums.

Therefore, these historically low volatility levels allow traders to purchase options or enter long option strategies at levels we have not seen since the early 1990s. Rarely do we see options premiums this low. Options on Gold futures and Treasury futures also are in single-digit percentile rankings, offering hedge fund portfolio managers exceptionally cheap long options opportunities.

Cheap vs. Expensive Premium

Volatility Percentile Rankings
Various CME Group Products

3-years ending 7/27/2017

Source: CME Internal Database

Hedge fund high volatility strategy managers can enjoy several benefits to trading equity index options on futures:

• 24-hour trading: Hedge fund PMs/traders can manage risk and initiate or offset positions around the clock, and liquidity is excellent as well. The evening after the BREXIT vote saw 475,000¹ options trade in CME Group markets. The night of the U.S. elections saw 655,000² options trade overnight.  When markets move, you can transact after hours with confidence.
• Capital efficiency: Capital is precious, and traders with futures and options positions can enjoy a potential margin reduction of 69-72 percent³ depending on the position.
• Exceptional volume/OI growth: Average daily volume on the E-mini S&P 500 options on futures alone has grown from 125,000 contracts a day in 2012 to 575,000 a day in 2017—a growth rate of 27% per annum⁴.  Figure 2 below illustrates how investors continue to make CME Group their preferred choice for equity options on futures.
• Extensive range of expiration choices. From quarterlies to weeklies to Wednesday and Monday expirations, hedge fund PMs can fine tune options strategies. European and American style expirations are also available.
• Seamless delta transition. Options on futures expire into a futures contract — allowing you to establish a continuous position in the market should you choose to exercise. Cash equity index options cash settle, and therefore require re-establishment of positions after expiration.

Source: CME Internal Database

Figure 3 below shows the significant impact of volatiltiy on options premiums. If volatlity were to advance from current from the historic lows we are witnessing now and revert back to only the 50^th percentile…..the ATM straddle would increase dramatically from $2,190 to $4,100 (assuming all other options inputs remain the same) 

E-mini S&P 500 Volatility Percentile Rankings Impact on Strategies

3-years ending 7/27/2017

Source: CME Internal Database

Visit cmegroup.com/equityoptions to learn more about our product offering and access tools such as:

• QuikStrike Options Tool, with powerful analytics, vol term structure, active strikes and more.
• Daily Options Reports, including trade recaps and spread activity
• CME Institute access, with in-depth courses, seminars and more at myfuturesinstitute.com

¹ Source: CME Internal Database

² Source: CME Internal Database

³ Source: CME Internal Database

⁴ Source: CME Internal Database