Chart — A sharp spike in near-term volatility late last week failed to be matched by fears for a longer-term pullback, causing the premium for futures contracts on the VIX index to invert to negative levels.
A strong rebound for US equities led by large-cap tech shares on Tuesday was matched with declining volatility measures in options markets and rising treasury yields. Despite the bounce, strategists at banks and brokerages are divided over the potential for a resumption of selling, with some arguing that high valuations remain vulnerable in the near term.
On Friday, the CBOE Volatility Index (VIX) reached the highest level since late January as the S&P 500 pullback from record highs reached a trough below -5% as the hawkish shift by the US Federal reserve and concerns over Omicron were digested by markets. As the spot VIX rose, the premium implied by near-month futures contracts tied to the index turned negative.
The last time the VIX futures premium fell so sharply into negative was during the autumn of 2020 when the historic post-pandemic rebound paused as rising Covid cases arrived in advance of the first vaccines and an outbreak in the White House threatened to disrupt the upcoming presidential election.
The VIX is a measure of current premiums paid by options buyers while the futures contracts tied to the VIX rise and fall with speculation on premium levels such buyers will be willing to pay in the future. An inversion of current versus future price expectations means that investors are willing to pay more for short term protection in the form of put options than the levels being asked for longer-term hedges by active traders in the futures market.
While VIX levels subsided as stocks rose on Tuesday, implied volatility measures remained elevated above intermediate term averages and proprietary risk indicators published by strategists at both BNP Paribas and Goldman Sachs suggested that further caution is warranted.
Fixed income markets also indicate lingering concern, with credit spreads for high yield benchmarks above recent averages. In a note to investors on Monday, Karl Haeling –a Director of Capital Markets for LBBW in New York, wrote that the potential for elevated U.S. November CPI to be released on Friday added to caution among bond traders.
US equity markets rebounded sharply in trading on Tuesday led by large-cap technology shares.
Some strategists warned that selling could continue as elevated valuations remain vulnerable to hawkish policy expectations and lockdown worries.
Volatility levels indicated by options markets suggest that many investors remain skittish.