GLRY - Volatility Is Likely To Return To The Stock Market Next Week

Summary

• The S&P 500 has been glued to 4,000 heading into this week's options expiration.
• That's likely to change next week when the option market resets.
• There could be a grab for puts ahead of the FOMC minutes.

Stocks have come roaring back since that cooler-than-expected CPI report on Nov. 10. However, the equity market has stopped dead in its tracks this week as it approaches Friday's monthly options expiration date, which has pinned the S&P 500 ( SPX ) down around the 4,000 level. That may be about to change.

Volatility should come back next week as the S&P 500 releases from the November options expiration date, as open interest levels drop and reset, allowing the market to move more freely.

Stuck at 4,000

Currently, the S&P 500 has been stuck around 4,000 because that's the level with the greatest concentration of options gamma. The region acts like a magnet, which is why the index has been unable to rise further this week, despite two recent attempts on Monday and Tuesday. Once these levels of options gamma reduce, it should give the market more room to move freely.

Implied Volatility Has Fallen

Much of the rally off the October lows has also been fueled by a sharp decline in implied volatility. But at this point, the VIX ( VIX ) is now at the lower end of its trading range, currently around 23. With the VIX already close to its lows, there may not be much energy left from the falling implied volatility to boost the market further. The decline in implied volatility was also a key feature that helped to life the S&P 500 in August.

However, what makes this time different from August is the current move lower in the VIX comes at the same time that the 30-day realized volatility is pushing higher, diverging from the falling implied volatility measured by the VIX index.

The last time the difference between realized volatility and the VIX was this wide was back towards the end of May. During that time, the VIX was steadily falling and realized volatility was rising, eventually leading to the VIX rising sharply, pushing stock prices lower into the June options expiration date, which marked a short-term bottom.

What this November rally does have in common with the August rally, other than the very sharp decline in the VIX, is that both rallies peaked (thus far) on the Tuesday before the monthly options expiration date, while the VIX bottomed around the same time.

It tells us that the tranquility and tight trading range will likely fade next week once the stock market loses the buffer of this Friday's option expiration date and is released from the 4,000 strike price.

Volatility May Be On The Rise

Additionally, shorter-date-date implied volatility has been decreasing, as noted by the VIX 9-Day Volatility Index, following the CPI data. It's heading toward the bottom end of its trading range.

Again, next week poses a challenge as it will feature the release of the FOMC Minutes on Nov. 23. The release could leave traders reaching for shorter-dated puts heading into the news. The FOMC minutes are already starting to be priced in, as noted by the bump higher in implied volatility on that date. The market's "general" view since the CPI report is that the Fed would likely not need to be as aggressive with rate hikes as previously believed because inflation rates are cooling. That makes it a possible risk for the markets heading into the release of those minutes should they read more hawkish than expected.

It seems likely that volatility will pick up again before this week is over or at the start of next week. The current state of tranquility seems to be near its end.

For further details see: