Stock Market Volatility Signals The Potential For An Unwind

Stocks finished the day higher, with the S&P 500 rising by 46 bps, while rates stalled along with oil. Implied volatility measures were also lower overall. Meanwhile, realized volatility has sunk, with 21-day realized volatility falling to 7.4%, which equates to a daily move of about 46 bps. So, if the index starts moving by more than 46 bps per day, realized volatility will expand, and if daily moves contract further, realized volatility will continue to fall. It can still go lower, but unless we start trading in even tighter daily ranges, that’s going to be difficult.

Implied correlation also fell today, with Cboe’s 1-month index down to 10.6 and my own proxies lower. But the bigger picture is that implied correlation has been grinding higher since early July, even as realized volatility kept falling and single-stock volatility continued to drop. It is also worth remembering that implied correlations have historically remained very low. Index vol has been holding up better than the stocks beneath it for the past 2 months.

Semiconductor implied volatility also fell on the day, even with Broadcom reporting results tonight, which I believe is due to a general lack of interest in the group.

That’s what is kind of odd here: the VIX has essentially stalled out since early August in a tight range, while realized volatility, single-stock volatility, and even semiconductor volatility have continued to fall. It suggests a couple of possibilities: either the VIX is going to fall to catch up with the decline in volatility, or investors are beginning to pay up for index-level hedges, even though you wouldn’t necessarily know it just by looking at the VIX.

It just seems like a recipe for something to unwind here, and right now we are just looking for the trigger event. Perhaps it doesn’t even need a trigger; perhaps now that Broadcom’s results are finished, the rest of that implied volatility will bleed out of the VIXEQ, and we’ll see single-stock volatility fall in the days to come.

-Mike

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Glossary by ChatGPT

Basis Point (bp) — One-hundredth of a percentage point, commonly used to describe changes in interest rates, yields, and market prices.

Implied Correlation — The market-implied degree to which individual stocks are expected to move together, derived from index and component option prices.

Implied Volatility — The level of expected future volatility embedded in option prices.

Index-Level Hedge — An options or derivatives position designed to protect against broad-market declines rather than moves in individual securities.

Realized Volatility — A measure of the magnitude of actual historical price movements over a specified period.

Single-Stock Volatility — The volatility of individual equities, measured either through historical price movements or implied by their options.

VIX — The Cboe Volatility Index, which measures the options market’s expectation of 30-day S&P 500 volatility.

VIXEQ — A measure or proxy used to assess implied volatility conditions across individual equities relative to broader index volatility.

Volatility Bleed — The decline in implied volatility as uncertainty or event-related option premium dissipates.

Volatility Compression — A period in which realized or implied volatility declines as market price movements become smaller.

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