An Earnings Season Unwind Could Catch The Stock Market Off Guard

The S&P 500 finished higher for a second straight day, and the index has just about filled the gap from Thursday. Not much has been accomplished over the last two days, which isn’t a surprise given how high the VIX 1-Day finished on Friday. The VIX 1-Day closed today at 12.5, and I would expect it to be close to 20 by 1:59 PM ET.

I seriously doubt the Fed would defy the market and raise rates one week before a midterm election. I could see a hawkish press conference, with Warsh staying tight-lipped on forward guidance.

That said, if Warsh wants everyone to know who’s in charge now, and that it’s no longer Bernanke, Yellen or Powell, he could go ahead and hike. There is certainly plenty of reason to. I think it would create a massive shitstorm, though

Once we get through earnings tomorrow and Thursday, single-stock implied volatility should fall, and dispersion should fall with it. If dispersion bottoms around 27 to 28 and single-stock implied volatility settles around 31 to 32, implied correlation could rise meaningfully, perhaps to 15 to 20, depending on how the cycle plays out, while the VIX stays relatively flat. That matters because falling single-stock volatility usually lets hedges unwind, and the buying that follows supports the market. However, if correlation rises, hedging flows on the index may turn negative, pushing the index lower to keep index volatility supported.

-Mike

 

Glossary by ChatGPT

Dispersion Index (DSPX): The Cboe S&P 500 Dispersion Index, which measures expected differences in returns among S&P 500 constituent stocks using options-implied volatility.

Federal Open Market Committee (FOMC): The Federal Reserve committee responsible for setting the target range for the federal funds rate and directing US monetary policy.

Forward Guidance: Communication from central banks about the anticipated direction of monetary policy intended to influence market expectations and financial conditions.

Hawkish Monetary Policy: A central bank policy stance that prioritizes controlling inflation, generally favoring higher interest rates or tighter financial conditions.

Implied Correlation: The average expected correlation among index constituents inferred from index-level and individual-stock options prices.

Implied Volatility: The market’s expectation of future price fluctuations derived from options prices.

Index-Level Hedging: The use of index futures, options, or underlying securities to manage exposure to changes in index prices, volatility, or other market risks.

Market-Implied Rate Probabilities: Estimates of the likelihood of future central bank interest rate decisions derived from interest rate futures and derivatives pricing.

Single-Stock Implied Volatility: The expected future price volatility of an individual company’s shares as reflected in its options prices.

VIX: The Cboe Volatility Index, which measures the options market’s expectation of S&P 500 volatility over the next 30 days.

VIX1D: The Cboe 1-Day Volatility Index, which measures the options market’s expectation of S&P 500 volatility over approximately one trading day.

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