Hint of Normalcy in Volatility Complex After Two-Day Stock Rally

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(Bloomberg) -- Equity bulls take comfort: There are signs order is being restored in indexes that measure stock market turbulence.

The S&P 500 Index’s implied volatility has fallen back toward its normal relationship to the same indicator for the more jumpy Nasdaq 100 and Russell 2000 indexes. It got out of whack as the S&P 500 careened to its worst week in two years amid the biggest-ever surge in the Cboe Volatility Index.

S&P 500 volatility-linked exchange-traded products may have contributed to the most violent moves, exacerbating the dislocation. As front-month VIX futures contracts spike, forced buying of futures tied to the so-called fear gauge also accentuated the downside for U.S. equities, which tend to move inversely to implied volatility. 

Meanwhile, trading in options tied to the S&P 500 -- which is what the Cboe Volatility Index is actually priced off of -- jumped as investors and dealer-desks scrambled to neutralize their exposure to a surge in volatility that had caught them offside.

A week later, gaps in implied volatility on the tech-heavy Nasdaq and small-cap Russell -- which generally swing more violently than the large-cap S&P 500 -- have returned to levels well off last week’s peaks, suggesting that the worst of the volatility-induced dislocations may be behind us.

Hint of Normalcy in Volatility Complex After Two-Day Stock Rally

Declines in the S&P 500 Index -- the measure slipped again on Tuesday after a two-day rally -- are rarely welcomed by stock bulls, but perhaps they’ll get some measure of comfort from a subtle sign that the tail -- implied volatility -- may no longer be wagging the dog.

©2018 Bloomberg L.P.

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