“I used to do a little but a little wouldn’t do it, So the little got more and more” – Guns N’ Roses
It’s almost uncanny, but the last three spikes in implied volatility in Europe have all reached the same level, while corresponding with market bottoms. It is also clear that it takes more and more volatility each time to goose a reaction from stock market investors, who are growing increasingly immune to the warnings signs.
Implied Volatility across Europe’s large cap stocks peaked on 24 June 2013, 16 October 2014 and most recently on 15 December. All three dates corresponded with a bottom in the SX5E Index, but the latest sell off was both the most rapid and benign of the three. The level of volatility across the top stocks remains highly elevated compared with normal and hence still requires close inspection, but the latest bout of panic appears to be over before it has really begun.
Volatility is uncertainty, but is also the degree to which option investors expect shares to have moved in three months time. The current average level of 26 across the STOXX 50 indicates an expected range of +/-13%. This is more than the index fell in the ten days to 15 December and it has rebounded 5% since then.
It is perfectly plausible that volatility traders betting on specific moves in share prices over precise periods will be correct, while long term investors continue to ride out this volatility in the belief that share prices are still trending upwards. Possible QE by the ECB would provide an explanation of both positions. However, volatility is not just confined to stock prices and monetary policy and the full fallout from the strength of the dollar, the weakness of commodity prices, especially oil, and the capital withdrawal from Emerging Markets has yet to be felt. Index option investors may not know or care precisely where this fallout will come, but individual stock option investors provide us with a guide.
The highest levels of implied volatility among the STOXX 50 constituents are at UniCredit, ING, Siemens, RWE and Nokia. However, the highest sector relative level compared to normal are at Unilever, Siemens, UniCredit and SAP, with elevated relative levels at BMW, BASF and ING. Unilever tops this list and its absolute and relative levels of implied volatility are both flagging red in OTAS, as are both the upside and downside skew on its three month options. EPS Momentum is barely changed, valuation in the normal range and CDS low, but it won’t have escaped the option market that the shares are developing a habit of crashing back down to the trend line in forward EPS estimates.