Dispersion Drives The Market To The Extremes
Dispersion continues to run very hot in the market, with the S&P Dispersion Index rising to nearly 41 and the 3-month Implied Correlation Index falling below 12. The spread between the two has climbed to a new all-time high of 29, which is notable because mega-cap earnings are essentially behind us, with the exception of NVIDIA. Under normal circumstances, this trade likely should have peaked a few weeks ago. However, with NVIDIA reporting results next week, the trade may finally be nearing its conclusion.
Ultimately, what appears to be driving this dispersion is that, rather than continuing to decline, implied volatility in the S&P 500 is actually rising. That means the average implied volatility for S&P 500 stocks is rising. Because the VIX is not rising, or at least not rising as quickly, it is creating a wider gap in implied dispersion.
One thing that stands out at this point is that 21-day realized volatility is 9.8, while the VIX is at 17.9. To me, that implies traders are betting that volatility will eventually return.
NVIDIA earnings next week could play a major role in this cycle, as we know that after NVIDIA reports, its implied volatility will likely fall sharply, which should help push dispersion lower.
For now, it is a tale of two markets. The technology sector is leading the S&P 500 by 19 percentage points, and every other sector is underperforming. In fact, the energy sector is underperforming the S&P 500 by 20 percentage points. Ironic, isn’t it?
Let us not forget that tomorrow is also a settlement day, and, based on what we saw on Tuesday, a weak trading day tomorrow would not be a surprise.
– Mike
Glossary by ChatGPT
21-Day Realized Volatility — A measure of the actual price fluctuations of an asset over the previous 21 trading days.
Dispersion Trade — An options strategy that profits from differences between index volatility and the volatility of individual stocks within the index.
Implied Correlation Index — A measure of how closely stocks within an index are expected to move together based on options pricing.
Implied Volatility — The market’s forecast of future price movement derived from options prices.
Settlement Day — The date when options and futures contracts are finalized and positions are settled.
S&P Dispersion Index — An index tracking the spread between implied volatility of individual S&P 500 stocks and the volatility of the overall index.
VIX — The CBOE Volatility Index, commonly used as a measure of expected volatility in the S&P 500 over the next 30 days.
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