MorningWord 3/20/15: It’s a Vol World After All

by Dan March 20, 2015 9:31 am • Commentary

I’ll keep this short and sweet this morning. From what sort of risk ignoring dimension are investors disregarding the volatility in, of all things, U.S. Treasuries. And why are they placing little if any concern in their lagging (in volatility terms) dumber younger brother, U.S. equities?

Here is a chart of the 30 day at the money implied volatility of the iShares 20 year U.S. Treasury etf (TLT) over the last year:

From Bloomberg
From Bloomberg

Obviously it has been elevated, but at 15 it is actually a couple points below the 30 day realized volatility of about 17.  While some would say options prices in TLT are cheap to its actual movement (which is hard to disagree with), I would suggest that the volatility in industrial commodities and currencies, suggest that equity vol could very soon prove to be way too low.

As we mentioned in this morning’s notable options activity post, a trader is betting that bond volatility continues:

TLT – While the bond market clearly sees the change in the Fed’s statement as a continuation of their dovish stance. A trader thinks we see even more volatility in bonds over the next month. A buyer paid $5.25 for 4500 of the April 128 straddles . This trade is slightly bullish (about 35 deltas) and breaks even at $122.75 on the downside and $133.25 on the upside.

But everyone is betting the other way in equities. Thirty day at the money implied vol on the S&P 500 index (SPX), while off its historical lows, is reflecting less than 1% intra-day moves, and is now basically even with that of its realized vol:

SPX 30 day realized vs historical vol from Bloomberg
SPX 30 day realized vs historical vol from Bloomberg

So we are likely to either see a major cooling in movement of almost every other risk asset in the world, or a marked pickup in volatility of U.S. equities.

This is not really a non-consensus view, but I am hard-pressed to think that the massive strength of the dollar, the continuation of abnormally low interest rates and crashing commodity prices won’t cause either a melt up or a melt down in U.S. equities very soon.