Potential Warning Signs Flash In Volatility Gains, Bond Yields

Volatility gains were tracked across a number of asset classes during several days of choppy trading last week. Last week marked the first time in a month that the S&P 500 (SPX) closed below its 50-day moving average, twice poking below the closely watched support line of 2100. Still, SPX remained between the 2080-2130 range that has held for a month.

Although no volatility gains are off the charts, these moves do materialize as the stock market enters the seasonally slow summer doldrums. Why are volatility gains picking up now? Is the options market sending out a warning flare?

Let’s start with the big dog: the CBOE Volatility Index (VIX). It’s sometimes called the market’s “fear gauge” because it tracks the expected volatility priced into short-term S&P 500 (SPX) options. When stocks stumble, the uptick in volatility and the demand for index put options tends to drive up the price of options premiums and sends VIX north (figure 1).

Last week’s move was relatively modest—the VIX rose just 3%. However, the index is now up nearly 18% since falling to 2015 lows just two weeks ago. Heading into VIX expiration, many traders continue to watch the 20 level based on aggressive buying of the June 18 and 20 calls, a play most are taking in anticipation of a higher volatility.

And, the VIX isn’t alone. The table below shows a number of other indexes that measure volatility in gold, small-caps, the euro, and more. Most moved higher last week.

Bond Market’s Influence

Another volatility measure of particular interest is the CBOE/CBOT 10-year U.S. Treasury Note Volatility Index (TYVIX). It’s a relatively new index created by the Chicago Board Options Exchange to measure the expected volatility priced into 10-year Treasury notes. TYVIX was up 5% last week.

The 10-year note’s yield is a closely watched indicator for interest rate expectations, and it’s been on the stock market’s radar increasingly as investors count down to the Federal Reserve’s first expected interest rate hike in years. Fed funds futures contracts show that participants have priced in a 56% probability that the Fed hikes rates beginning in September.

In anticipation of the Fed changing rates this year, Treasury instruments have had rough going over the past few trading days as stronger-than-expected job market statistics and other data sent prices skidding. The yield on the benchmark 10-year note topped 2.4% for the first time in 2015. That’s a far cry from the late-January lows of 1.65%.

Recall that sudden moves in bond yields, in the current climate, rising bond yields, can sometimes drive choppy trading in the equities market, especially in interest-sensitive sectors often sought out for their dividends. We’re talking about some utilities, consumer staples, and health care names.

On the Docket

Bond yield fluctuations are likely to keep traders on their toes into retail sales and inflation data due out later in the week (see figure 2 for the complete economic indicator schedule). Industry economists think retail sales could accelerate in this report based on solid auto sales figures and the impressive May jobs report that included a pick-up in wages.

Earnings releases have lightened until Q2 results flood the market beginning in mid-July. But a few names to watch this week include home builder Hovnanian HOV and athletic apparel company Lululemon LULU, both reporting on Tuesday. Krispy Kreme KKD and Men’s Wearhouse MW are among a very small handful of names scheduled for reports midweek.

Of course, headlines from overseas continue to drive trading at home and abroad. Greece uncertainty had been a leading factor hanging over U.S. stock indexes in recent sessions. But a temporary fix appears to have calmed nerves for now. Greece’s June 5 scheduled debt payment to the International Monetary Fund was postponed and bundled with other debt due on June 19. In addition, China’s Shanghai Composite continues to see wild moves from one day to the next.

All of these developments near and far could add to the volatility creeping up in rising bond yields. Needless to say, stock traders are increasingly de facto bond traders. And that’s not likely to change anytime soon.

Good trading,
JJ
@TDAJJKinahan

This piece was originally posted here by JJ Kinahan on June 8, 2015.

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