It doesn’t take a genius to know that the day after the Greek banks are shut down and the Athens stock market closed, equities across the rest of Europe are going to fall; or to use the more euphemistic phrase, be volatile. But have you noticed how markets always seem to recover a little as the day wears on, as the initial view is treated as an overreaction, even if tomorrow is going to bring more selling. Ever wanted to be able to trade that?
Higher volatility is what a lot of market commentators have been predicting for some time, for a variety of reasons including;
- recent extreme volatility in bond markets (the type of statistically impossible volatility that standard risk models, which all the big guys use, fail to anticipate)
- the gap between very low realised volatility and higher implied volatility
- changing market structure, including the rush of retail investors into collective investments based on increasingly illiquid sub segments of the market
- intellectual opposition to QE and a secret desire to be proved right through inflation, interest rate hikes and goodness knows what political fall out from the unequal distribution of “unorthodox monetary policies”.
There are a number of ways in which OTAS can help manage money in such an environment. These range from long term analysis of volatility in equities for the patient fund manager, to mean reverting intraday trading analysis for those charged with spotting day-to-day over reactions. Here are some examples of how it works.
I’ll use the STOXX 600 for reference, but remember you may use OTAS to analyse any market, sector or your own portfolio, for example to look at defensive and aggressive stocks to see if they will actually behave as they’re supposed to.
Implied volatility in options at the back end of last week was suggesting an average three month move in STOXX 600 components of +/- 12.5%. The normal range of this measure over the previous year was +/- 10.5% to +/-12.5%; so a narrow range with the latest figures near the top. The extremes of implied volatility over the past year, beyond which the OTAS red flags really do wave, were +/- 9.5% and +/-13.5%. This is not a wide range at all, barely allowing for a proper correction.
To put this in context, let’s look at implied volatility over a much longer period. Here we see the current fluctuations as very minor and bumping along the bottom of the normal range over the past decade.
The two periods of far higher implied volatility came at the back ends of 2008 and 2011 and help skew the average volatility over the period to +/-14.25%. Recently, this historic context has been a soothing balm for investors, allowing them to point out how far from the bear market conditions of yesteryear the current market was. However, an event like Greek banks being shuttered focuses attention on how far volatility could rise, even if it were still in the normal range.
And this is not good volatility for most investors; we are talking markets falling.
This measure will be fascinating for OTAS Subscribers to watch over the coming days and should provide advanced warning of when things calm down again.
The next thing to do is to rank your investable universe by implied volatility, to check that the option market shares your views of which constituents among your holdings will move around the most in the coming weeks. To a large extent this is intuitive, with the highest volatility stocks those that have been bid for recently (although confirmed cash price bid targets are among the most attractive investments in falling markets) followed by a number of names from the capital goods, energy and technology hardware sectors.
The least volatile names are those companies that were bid for some time ago and where deals are awaiting completion, but also Swiss stocks across a number of sectors and some very large cap names in sectors such as Energy. It is worth knowing if you believe the market will correct that option investors expect you to lose less in a relatively small Swiss, diversified financial stock than in a far larger German insurer, or a Dutch food and beverage maker, for example.
For those focused on intrade analysis, OTAS Tradeshaper ranks stocks by idiosyncratic performance, meaning stocks that have diverged significantly from the basket of shares that they are most correlated with. Today’s trading is not yet two hours old, but there are a number of stand out performances.
Traders that use OTAS may rank order pads by best or worst performances, volume, bid or offered liquidity and spread, or simply leave TradeShaper to monitor the pad and flash an alert when any of these factors exceeds normal bounds.
The temptation is always greatest to focus on your largest orders, often those in the largest shares, or even those where the loudest fund manager demands attention. These are rarely the stocks that require the most attention, or offer the best opportunities to trade now. TradeShaper arms traders to enable better decision making, and crucially provides the evidence to justify those decisions in the heat of the moment and the cold analysis of tomorrow.
Over the last few weeks our team of in house experts has been watching idiosyncratic divergence from the norm among large cap, European stocks and using OTAS alerts to pick entry and exit points for intra day traders. The results have been remarkable; to find out more contact email@example.com or firstname.lastname@example.org.