Implied volatility on S&P 500 options has been exceptionally low recently. But is that about to change?
When looking at the implied volatility on S&P 500 options and the slope of the yield curve side-by-side, there doesn’t seem to be an obvious relationship.
However, when taking the two-year moving averages of implied volatility and the yield curve shape, a pattern that has been repeating for over three decades emerges.
For example, in the United States in the early 1990s, a flat yield curve reflected tight monetary policy and high volatility in the equity market. This coincided with the 1990-91 recession. As a result of the downturn, the Federal Reserve lowered rates, and the yield curve steepened. By 1994, the U.S. had a steep yield curve, and implied volatility had fallen to low levels. So, the Fed raised rates, flattening the yield curve in 1994 and 1995. Initially, implied volatility didn’t rise, but by 1997 it began an uptrend that culminated with the 2001 tech wreck recession.
The Fed again eased policy in 2001 and 2002, which steepened the yield curve and reduced implied volatility on equity options. By 2004, with a recovering economy, the Fed began to tighten again, which flattened the yield curve and ultimately translated into the wave of volatility that accompanied the Global Financial Crisis.
The cycle repeated between 2008 and 2020. Currently, the yield curve is steeply inverted. If history is a guide, today’s tight monetary policy might translate into a wave of volatility in coming years.
OpenMarkets is an online magazine and blog focused on global markets and economic trends. It combines feature articles, news briefs and videos with contributions from leaders in business, finance and economics in an interactive forum designed to foster conversation around the issues and ideas shaping our industry.
All examples are hypothetical interpretations of situations and are used for explanation purposes only. The views expressed in OpenMarkets articles reflect solely those of their respective authors and not necessarily those of CME Group or its affiliated institutions. OpenMarkets and the information herein should not be considered investment advice or the results of actual market experience. Neither futures trading nor swaps trading are suitable for all investors, and each involves the risk of loss. Swaps trading should only be undertaken by investors who are Eligible Contract Participants (ECPs) within the meaning of Section 1a(18) of the Commodity Exchange Act. Futures and swaps each are leveraged investments and, because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for either a futures or swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles and only a portion of those funds should be devoted to any one trade because traders cannot expect to profit on every trade. BrokerTec Americas LLC (“BAL”) is a registered broker-dealer with the U.S. Securities and Exchange Commission, is a member of the Financial Industry Regulatory Authority, Inc. (www.FINRA.org), and is a member of the Securities Investor Protection Corporation (www.SIPC.org). BAL does not provide services to private or retail customers.. In the United Kingdom, BrokerTec Europe Limited is authorised and regulated by the Financial Conduct Authority. CME Amsterdam B.V. is regulated in the Netherlands by the Dutch Authority for the Financial Markets (AFM) (www.AFM.nl). CME Investment Firm B.V. is also incorporated in the Netherlands and regulated by the Dutch Authority for the Financial Markets (AFM), as well as the Central Bank of the Netherlands (DNB).