Options Quarterly Commentary Q3 2024

U.S. equities ended the third quarter of 2024 with a strong performance, despite elevated market volatility on multiple occasions. Whilst September has historically been the worst performing month for equity markets, the S&P 500 SPX ultimately closed Q3 24 at 5762.48 (up 5.9% vs Q2 24). Volatility throughout the quarter was driven by geopolitical tensions in the Middle East, weak U.S. economic data and uncertainty around Fed rate cuts. The CBOE Volatility Index (VIX) ultimately closed the quarter at 16.73 (up 35.5% v Q2 24), reaching a high of 65 (highest print since COVID) in premarket trading on August 5^th. Global markets were shocked when the BOJ unexpectedly raised interest rates, in turn seeing markets violently sell off on the forced unwind of the Yen carry trade. However, markets quickly digested this event as an isolated incident as opposed to a broader macro concern, and equity markets quickly recovered back to all-time highs.

Source: Bloomberg

We saw an additional bout of volatility approaching the FOMC meeting on September 18^th, with the options market pricing in a 1.2% swing in either direction for the S&P 500. Following the Fed’s 50 basis point cut the S&P500 closed down –0.29%, with the real volatility ‘payoff’ coming the following day as the S&P500 soared +1.70% to a fresh all-time high. As noted in an article by JP Morgan, a sector rotation occurred during this period with value stocks outperforming growth stocks by 7%, plus a rally in small caps stocks, which typically perform well in low-interest rate environments.

As we head into the fourth quarter, we are likely to see sustained volatility due to continued geopolitical tensions and uncertainty around future Fed cuts and the upcoming U.S. presidential election. According to EqDerivatives, the main driving factor for elevated implied volatility premiums relative to realized volatility is due to the strong performance of the S&P 500. Said another way, on our desk we are seeing many investors’ demand for traditional put buying return to lock in the gains they are sitting on heading into year-end, which has helped push up implied volatility. On the flip side, the NTSI options desk has seen some clients choose to take advantage of this volatility premium through both increased put selling and covered call writing.

Source: Bloomberg

As noted by Nomura, investors are increasingly looking to hedge their portfolios against macro event risk to lock in their positive PnL as we approach year-end. This increased demand for downside protection has caused out of the money put skew to rise to 99% percentile (as illustrated below). Conversely there has been less demand for upside exposure, reducing the 3 month at the money call skew down to 2% percentile.

Source: Nomura

According to the CEO of Parallax Volatility Advisors, with regards to the U.S. election, investors are being patient and so far, there hasn’t been a significant uplift in tail hedging ahead of vote day with the largest flows being mainly from volatility sellers. Analysis from UBS has shown that so far options markets are pricing in an estimate of 2.8% move in either direction the day after the vote and this figure is expected to rise further as we get closer to vote day. Due to the uncertainty over the outcome of the election and implied volatility rising, volatility trades are seemingly more popular than directional ones. As noted by EqDerivatives, historically in election years the VIX tends to increase entering into October, before selling off right before the event and although S&P 500 options are pricing in potential swings on the day immediately after the vote, implied volatility for subsequent days is much lower.

Investors can take advantage of this period of volatility ahead. An article from BlackRock observed that historically, higher volatility has produced higher returns in the short term. When VIX levels are at 12 or below, the SPX returns roughly 5% six months later. As a comparison, when the VIX reaches 29 or higher, the average six-month returns are 16%. Volatility spikes like we have seen over Q3 can create buying opportunities with potential for higher short term returns.

Options involve risk and are not suitable for all investors. Call for a copy of the Options Clearing Corporation (“OCC”) Disclosure Document entitled "Characteristics and Risks of Standardized Options." Please read it carefully before investing.

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