Summer Doldrums
Morningstar Volatility Report for Aug. 20, 2010.
Investing Specialists
Introduction
The Morningstar approach to options is focused on using company and economic fundamentals to interpret and estimate the value of the uncertainty around market prices, as reflected in implied volatility in the options market.
Government Data So-So at Best, but Corporations Hanging in There
As is typical at the tail end of earnings season and a few weeks before the Labor Day break, trading volumes were again light this week. A big drop in the market toward the end of the week drove up volatility levels at the time, but the VIX Index of market uncertainty still ended the week lower than its previous weekly close.
A dearth of important economic news early in the week contrasted with various news stories across the corporate landscape. A congressional report on Monday saying that repayments of loans made to for-profit education companies such as Strayer Education (STRA) and Corinthian Colleges were below the 35% level. Education stocks (with the exception of Morningstar Option Portfolio holding Apollo Group ) sold off strongly as investors worried that the government would impose expensive oversight measures to for-profit operators or refuse to offer subsidized loans to students of these institutions. On the other hand, news that Dell had agreed to acquire 3Par at a hefty premium was touted as a reason for some optimism.
This optimistic merger theme was continued on Tuesday when BHP Biliton (BHP) made an offer for Potash Corp. of Saskatchewan (POT)--a fertilizer maker--in an all-cash and sizable proposed deal. Whether it was the optimistic tone set by this activity or fairly good news from retailing giants Wal-Mart Stores (WMT) and Home Depot (HD), the market rose strongly on Tuesday and option uncertainty fell. Government data was mixed--industrial production coming better than expected, but housing data was a bit worse.
Until the weekly initial claims report, published on Thursday, there was little important news, though on Wednesday, retailer Target (TGT) gave a confirming data point to that reported by Wal-Mart the day before with strong earnings and guidance. On Thursday, initial claims for unemployment came in worse than expected and even hit the frightening 500,000-person mark. Later that morning, the Philadelphia Fed Manufacturing Index--a widely-watched measure of regional manufacturing health--was released and reported an unexpected contraction for the first time in more than a year. Lingering concerns about a double-dip floated to the surface again and the market tanked--loosing almost 2% of its value--while volatility soared.
Index futures pre-market on Friday made it look like as though another bloodbath awaited investors upon the open, but the market firmed in the afternoon and closed down only 4/10 of a percentage point on the day.
Despite a slight firming on Friday, the S&P 500 Index finished the week 0.7% below last week's close. Despite the slight equity markets fall, market participants believed that, on balance, uncertainty had also decreased--the VIX closed 2.3% lower on the week.
The Numbers
The VIX index of S&P 500 implied volatility swung between a range of 23.4% (on Wednesday) and 28.1% (Monday morning), and closed the week at 25.6%.
Small-Stock Uncertainty
The spread between implied volatility on the Russell 2000 Index of small stocks (RVX) and the VIX index of implied volatility on the large-cap S&P 500 decreased very slightly and is now 9.0 percentage points. This spread indicates the market is more and more concerned about small companies relative to large companies.
Uncertainty About Next Quarter vs. This Quarter
At the tail end of the fiscal second-quarter earnings season, the spread between the implied volatility of the three-month options on the S&P 500 Index (VXV) relative to the implied volatility of the one-month options represented by the VIX rose slightly; the spread between the two indices is now a positive 3.9 percentage points.
Expected Correlation
The S&P 500 implied correlation index (JCJ) measures the expected correlation between the stocks in the S&P 500 until January 2011. Implied correlations continue to rise and fall in unison with the VIX, suggesting that uncertainty regarding macroeconomic issues is paramount to company-specific issues. Implied correlation closed at 77.9%, down 1.2 percentage points from the previous week's close.
Based on these measures, we continue to think the market is more concerned about macroeconomic issues and the strength of the economic recovery in the U.S. than company-specific issues.
Erik Kobayashi-Solomon is co-editor of the Morningstar OptionInvestor online newsletter and research service, and is co-author of the Morningstar Investor Training course on Option Investing. For more about Morningstar's fundamental approach to investing in options, please use the link below to download our free guide to option investing:http://option.morningstar.com/OptionReg/OptionFreeDL1.aspx
|
