The dog days of summer are upon us. While August has historically brought volatility to markets, equities in 2020 appear to have shrugged off their typical late-summer doldrums, posting solid gains to start the month. However, some warning signs are flashing of possible bumps ahead. In this note we discuss what the options market is telling us about potential volatility in the coming months – and what investors can do now to prepare.
Historically, August has been a tough month for stocks. The average S&P 500 return in August over the past 15 years is -0.17%, and these meager returns are often accompanied by an increase in volatility. But equities have looked tame lately, with 1‑month realized volatility clocking in at just 10.2%, and the average daily move of the S&P 500 over that time period has been just 30 basis points. This market would feel extremely placid even under normal economic circumstances, let alone our current macro backdrop.
S&P 500 rolling 1-month realized volatility
Source: Bloomberg, November 30, 2017–August 10, 2020.
Markets are just a few months removed from the acute pain many experienced during March’s sell-off, when realized volatility reached 92%. As markets have recovered in extraordinary fashion, volatility has receded. But year to date realized volatility remains high from a historical context, at 41.35%, whereas long-term averages are in the mid-teens. With headline risks extreme – a pandemic, a looming U.S. presidential election and geopolitical tensions, to name a few – markets feel downright complacent. The dichotomy between implied and realized volatility measures would agree, as these signals in options markets are pointing toward heightened volatility ahead.
Key takeaways:
- Markets have felt complacent recently, but signs in the options market point to equity volatility ahead.
- Both the VIX curve and the spread between implied and realized volatility indicate expected levels of heightened near-term volatility.
- Investors should act now to position portfolios accordingly; many liquid alternatives are compelling diversifiers.
