Displaying items by tag: risk

In an article for MarketWatch, Mike Murphy covered a recent report that state and federal regulators are examining unusual trading patterns behind the recent volatility in bank stocks. Notably, the entire banking sector and specifically regional banks, have been subject to heightened volatility and heavy short-selling in recent months following the failures of banks like Signature Bank, First Republic, and Silicon Valley Bank.

In recent weeks, there have been big declines and large amounts of put buying in the stocks of regional banks like PacWest, Western Alliance, and Zions. The core challenge for these banks is that they made long-term loans at much lower rates, yet they have to increase short-term deposit rates or risk depositors leaving for higher rates elsewhere. And the risk of this deposit flight increases if concerns about a bank’s financial health increases.

Both the White House and the SEC noted the short-selling pressure on banks possibly contributing to the volatility. In a statement, SEC Chair Gary Gensler said, “In times of increased volatility and uncertainty, the SEC is particularly focused on identifying and prosecuting any form of misconduct that might threaten investors, capital formation or the markets more broadly.”

Finsum: With increasing volatility in the banking sector, regulators and public officials are examining short-selling and put buying as factors that may be adding to volatility.

In an article for Reuters, Mike Dolan discussed the widening gap between market volatility which has been trending lower since October of last year and headlines of various geopolitical, financial, and economic risks that are increasingly dominating headlines. The Federal Reserve is expected to hike rates despite signs that the economy continues to decelerate, considerable stress in the banking system, increasing chatter of a ‘technical default’ for the US Treasury if the debt ceiling is breached, and important data points in the coming weeks in the form of earnings from tech giants and the April jobs report. 

Despite these potential threats, the VIX, which measures stock market volatility, reached its lowest levels since November 2021. The stock market is also nearing a 20% move rise from its October lows, which many market participants would define as a new bull market. Volatility is similarly depressed in the Treasury market and the currency markets despite upcoming central bank meetings, indicating that this divergence between the VIX and headline risk is not unique to equities.

Finsum: There is a widening gap between various headline risk and market measures of volatility which are at multi month lows. 

In an analyst note, JPMorgan’s Chief Equity Strategist Marko Kolovanic discussed the anomaly between an increasingly shaky market and economic outlook, in contrast to the S&P 500 volatility index (VIX) which continues to trend lower. 

A week ago, the VIX dropped to 16 which is its lowest level since November 2021, despite the S&P 500 being 16% lower compared to 17 months ago. Yet, economic growth continues to decelerate, inflation is meaningfully higher, and the Fed remains in a hawkish posture. 

Kolovanic notes that we are not likely to see any abatement of these pressures in the coming months given the tightening of financial conditions and rising recession risk, while the Fed’s priority remains stamping out inflation even at the expense of the economy and labor market. Further, he notes stress in the banking system and drumbeat of rising tensions regarding China, Russia, and an upcoming election cycle.

He says depressed volatility is due to technical reasons, primarily the selling of short-term options which leads to dealer buying of stocks and volatility leaking lower. Adding to this is continued resilience in Q1 earnings while many were anticipating a meaningful decline. 

Finsum: Volatility is at 17 month lows despite stocks being much lower. JPMorgan’s Marko Kolovanic explains some reasons behind this discrepancy. 

For bond traders, 2023 has been one of the most volatile years in recent decades. It’s not entirely surprising given the various forces impacting the market such as inflation, a hawkish Fed, a slowing economy, and significant strains to the banking system.

In a Bloomberg article, Michael Mackenzie and Liz McMormick discussed reasons why these conditions will persist for the remainder of the year. In response, investors are looking to remain nimble and flexible especially given wide swings and a risky environment. 

Bond traders are expecting this uncertainty to continue as long as the Fed continues its hiking cycle and gets clear when it will start cutting rates. A major factor in Treasury inflows has been the slowing economy as recession fears increase, however the labor market continues to add jobs, and the economy continues to expand. Additionally, the recent spate of bank failures and financial stress also was supportive of Treasury inflows. 

Maybe the best illustration of the volatility is the 2-Year Treasury yield which got as high as 5.1%, following Fed Chair Powell’s hawkish comments. And. it got as low as 3.6% a few days later amid the failure of Silicon Valley Bank.

Finsum: The bond market has experienced incredible volatility in Q1. However, odds are that this volatility will continue all year. 

Short-term dated options are continuing to grow in popularity which many analysts are warning could have unintended consequences for market stability according to a Reuters article by Saqib Iqbal Ahmed.

The fastest growing segment is zero days to expiry (ODTE) options, where traders are looking to profit from small, intraday market moves. Most options are based on indices, popular ETFs, or single stocks. As of March 2022, the daily notional value of all ODTE trades had exceeded $1 trillion.

The contracts are popular among buyers, because small moves in the underlying instrument can result in huge moves for its derivatives. For sellers, the appeal is that the options decay in value and the trade can be closed at the end of the day. 

However, many warn that large positions in these options could set off a ‘squeeze’ in the event of an unexpected, intraday move. This would cause option sellers to take large losses and potentially force hedging which could exacerbate the move in the underlying instruments. According to JPMorgan, it would be a similar dynamic to the ‘Volmageddon’ crash of 2018 when many inverse volatility products crashed due to a large spike in the VIX.

Finsum: A new threat to market stability is the rise of ODTE options which are becoming very popular with retail and institutional traders. However, they do have the potential to exacerbate large, intraday market moves.