Following the U.S. election and news of two promising COVID-19 vaccines, implied volatility on S&P 500® and Nasdaq-100 options has plunged. In the case of the Nasdaq-100, the VOLQ index of volatility fell from 39.4% on October 29 to 23% by November 18. The QuikStrike tool shows the cost of at-the-money options on the S&P 500 falling from 32.6% to 18.4% over the same period (Figure 1).
The decline in implied volatility wasn’t limited to the equity market. Implied volatility dropped sharply on U.S. Treasuries as well (Figure 2). It appears that investors have breathed a sigh of relief post-election and in response to vaccine news.
With respect to current options market pricing, a few things stand out:
For much of the summer this year, Nasdaq-100 options cost significantly more than those on the S&P 500, with the ratio of the implied volatility rising as high as 1.6. In the weeks before the election on Nov 3, the Nasdaq-100/S&P 500 volatility ratio came down to just 1.1. Since October 29, implied volatility has fallen proportionately further on the S&P 500 options than on the Nasdaq-100, bringing the ratio back up to around 1.4 (Figure 5).
It seems clear that investors see Nasdaq-100 and S&P 500 risks differently. This could be because the Nasdaq-100 includes many firms that have performed well despite the pandemic.
The rise in Nasdaq/S&P 500 volatility ratio over the summer had a lot to do with the much stronger upward trend in the Nasdaq-100, whereas the S&P 500 and the Russell 2000 stuck closer to the performance of consumer spending (Figure 6). The strong upward trend in the Nasdaq-100 appears to have made investors nervous about a sharp pullback, which indeed happened in early September. As that pullback was underway, the Nasdaq-100 volatility ratio fell.
Now with the vaccine news, the S&P 500 and Russell 2000, with high weightings to firms that have been adversely impacted by the pandemic, have rebounded, while the Nasdaq-100 has underperformed. An end to the pandemic could also impact future earnings growth for firms that specialize in online delivery, social networking, virtual internet meetings and the like. This may be why VOLQ in the Nasdaq-100 has not fallen as much as the implied volatility on the S&P 500.
More broadly, we wonder if the decline in implied volatility across equity indices and long-term bonds might prove to be short lived. Given the state of the global economy, the continuing threat of the virus in the US and Europe, the inability of monetary policy alone to support economic activity, and the uncertainty surrounding further EU and U.S. fiscal stimulus, it’s unclear if implied volatility might be at risk of heading higher once again. That said, with positive vaccine news, investors appear to be looking beyond any fall/winter valley towards the next peak in economic activity.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.
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Nasdaq-100 Volatility Index futures, or VOLQ futures, provide a way to hedge exposure to, or express a view on, the implied volatility of the Nasdaq-100 Index.