How moves in the VIX can make market makers fearful
Steve Sosnick, chief strategist of Interactive Brokers, joins Yahoo Finance to discuss what the VIX moves are saying about the market.
– This is Yahoo Finance Live. We are looking at futures that indicated a slightly lower open, so far. Now they have reversed and they point to a very slightly higher open, perhaps building on the big gains we saw yesterday in the major averages.
Let’s take a look at Steve Sosnick, the chief strategist of Interactive Brokers. And Steve, one of the similar themes – which we talked about a few weeks ago – is about the kind of discrepancy between what we would normally expect from the VIX at a time like this, and what is going on underlying them. actions. And is that we still see a relatively high VIX, and a high VIX curve, as stocks recover. Which is confusing for some people. And as Miles has spoken of many times, this has led Marko Kolanovic – above JP Morgan – to say that we may even see a bubble in the VIX. So I am curious, first of all, to have your opinion on this kind of speech.
STEVE SOSNICK: As much as I respect my colleague from JP Morgan– my colleague, he’s a much more renowned strategist than I– he– I’m going to push him away, on this one. Because this one – there are a few things that I think it lacks, in terms of VIX. And that’s where having been a trader for so many years comes into play.
Part of the thing with … part of the thing that I think people are looking at. You know, he said it’s very high relative to historical volatility. As far as I know, it was using historic volatility near the close. And if you want an example of how this fails you, think of a day like last Wednesday where we dived for most of the day and then closed essentially unchanged.
Well if you use historical volatility close to the close that is around zero and goes into the calculations going forward as close to zero. The problem is, if you are a trader, you consider this day to be an incredibly volatile day. I’m using – I’m going to use a high-low volatility calculation – which is sorry to be really esoteric, here – but I’m going to worry if I can make money by trading – by trading my gamma , covering my wallet, buying low, selling high. And I’m going to add 2% volatility to that equation, that’s what we’ve seen. This equates to an annualized volatility of 32%.
So this is the first part. So depending on whether you are just using historical volatility near the close, the VIX will always look high. Because professionals, who trade the options that would make up the VIX calculation, use high-low volatility. Because that’s how they trade.
Second, the below market option – the VIX takes a wide range of options, so the below market options have always kind of pushed the VIX up. They’ve been doing this since 1987 when the world sort of realized they needed a little downward bias. And it was better to hedge with options than to try and sell futures in a bear market. The difference is now – and I hate to use the term “it’s different this time”, because those are extremely dangerous words – but right now what we’re seeing is with all this speculation on the calls, upward calls also raise the VIX. They actually had a slightly depressing effect on VIX.
So you have this combination that also works. This last part may or may not be sustainable, in the longer term. But as long as we see demand for calls, we’ll see an additional premium – which we’re seeing on VIX – over what we normally see on historic volatility near the close.
– Steve, in a simpler way – if it’s possible for volatility, and that sort of thing –
STEVE SOSNICK: Sorry.
– Are the markets just – are the markets just looking at one – or are traders just anticipating a different market environment now, than they were two years ago? And is that maybe going to change a lot of these comparisons that strategists try to make? What about the themes that they try too hard to describe to their clients, when clients ask what is going to happen to the stock market?
STEVE SOSNICK: Yeah, that’s interesting because at the same time you’ve kind of – you’ve had the Fed more or less of a rush on volatility for a while. Because with the amount of – I’ll call it – the stimulus, and so forth, it should somehow have a reducing effect on volatility. But I think it’s gotten so extreme that we’re seeing the opposite.
And again, what we’re seeing now that we really haven’t seen before – maybe for a short time in 1999 – was this mad speculation about the calls. And what’s happening now is the markets are adjusting to that. If you’re a call writer – many of whom I guess are the folks watching this – you’re going to charge an extra premium for the calls you write. Market makers certainly do.
And so you see a different environment now. Whether this is a definitely different environment remains to be seen.
– And then we had the opening bell on Wall Street. Yet another SPAC, TCW, ringing the opening bell. Steve, let’s look at the market from a 100,000 foot perspective. And I’m sure you saw the new ultra-millionaire tax proposed by Elizabeth Warren yesterday. 2% annual tax on household and trust equity between $ 50 million and $ 1 billion. What do you think this has an impact on the market? And I’m asking management this – maybe the market doesn’t understand how much taxes – corporate taxes, maybe even personal taxes if there is a trade tax – maybe that it comes into effect somewhere, well, under the Biden administration within the first two years. And stocks at these levels do not properly reflect this reality.
STEVE SOSNICK: Well, Brian, I think a wealth tax is going to be a big challenge. I think … you know, think about who pays the lobbyists. And I have a feeling it’s going to be difficult to go through. I think in the – you know, I think in terms of transaction taxes, it’s going to be tough as well. I think that would really throw sand in the cogs of the market, if you were successful in doing it.
I think right now – and in many ways this ties in with Julie’s original question – VIX futures are showing a high level in April and May. And I think it has to do with the more basic income taxes people have to pay. I think market makers are concerned that the public, who have successfully speculated, will have to take money out of the market to pay their regular income taxes. Because I think people are going to be a little blown away by their tax bills if they are successful in trading. And invest for the short term, like a lot of people have done.
So the 100,000-foot view? It’s difficult. Right now the one thing I would say more than anything is what scares me the most, is the lack of fear itself. But I think when it comes to specific taxes, I’m going to say we’re going to go through the tax season of April 15 first. And then start to worry about some of those things, which can really rock the basket of apples if they come in, in a lot of ways.
– Hey, Steve, is the futures curve also steep due to concerns about inflation and / or bond yields? Perhaps fear is too strong a word, since we are also looking at strengthening the economy. But how much do we have to do with what seemed like – a tantrum, again, too strong a word – but those kinds of jolts in the market that are caused when we see higher yields.
STEVE SOSNICK: I’ll call it a pre-tantrum. I think people are starting to worry that there might be a tantrum. We have a lot of Fed-speak this week. I think the chairman made it very clear that we don’t increase rates — we don’t increase inflation rates until we see the white of their eyes, sort of thing. But let’s see what other Fed Governors have to say when they speak up this week.
I think a year and a half is not necessarily enough to worry people. I think a seventh – a 3/4 addition, too, is probably the next level of concern. I think what surprised people was that along the way, people expected the Fed to intervene on the long-term yield curve when it hit a, or when it hit. one and a quarter, or a year and a half. And we haven’t seen that. And I don’t think they want to do it. I think it adds a bit of risk to the market. But not in a really unhealthy way, because – again, what we’re talking about is strangely a risk of strengthening the economy. And I think at the end of the day everyone wants a stronger economy, even though that may have unforeseen effects in the market. On the stock market, per se.
– Steve Sosnick, Chief Strategist of Interactive Brokers. Thank you very much to you and your argument Lael Brainard from the Fed speaking at 1:00 pm today. So while she didn’t address this issue yesterday in some comments, we’ll see if she does today.