Key Takeaways
- War Could Mean More Market Turbulence
- Bond Cash Markets Closed Today
- Skew May Make Puts Expensive
Wars in the Middle East and Ukraine. A looming government shutdown. No Speaker of the House. Rising interest rates. This is one of the most geopolitically contentious periods I’ve seen in my trading career. Given these challenges, you might expect markets to look much worse than they do. The pace is something to keep in mind, the market usually takes its time in assessing certain risks and war is chief among those. The loss of innocent life is always tragic in these situations and that is the saddest part of these situations. Outside our very human emotions of anger and sorrow, the market takes a less emotional view. Unfortunately, these conflicts often come to an immediate stop or play out over a much longer period than people would originally think, this helps explain why the market has a more muted reaction than many may think. In premarket activity, the S&P futures are down just over 0.5% and Nasdaq futures are off by 0.8%.
On Friday, stocks initially sold off following the stronger than expected jobs report but then turned around to not only recoup losses, but surge higher. The S&P 500 gained 1.2% and 0.5% for the week, snapping a four week losing streak. The Nasdaq Composite closed higher by 1.6% for both the day and week. Still, both indices are off their July highs by 6.5% and 7%, respectively.
Looking beneath the surface, there’s a little more damage than meets the eye. According to a Bloomberg article, more than 180 stocks in the S&P 500 are now trading lower than they were a year ago. In fact, 267 stocks in the S&P 500 are down year to date. This is something I’ve discussed a few times, pointing out the market’s gains are very concentrated in just a handful of stocks.
In addition to events in the Middle East, this week is filled with potential pockets of volatility. A number of Fed members are scheduled to speak throughout the week and I’ll be listening for any hint as to what they will do when the Fed meets at the beginning of November. We’re also going to get some important economic reports. Both the Producer Price Index (PPI) and Consumer Price Index (CPI) are scheduled for release Wednesday and Thursday, respectively. Then on Friday, earnings season will kick off with bank stocks reporting first.
Oil is up a little over 4% in premarket. Anytime something happens in the Middle East, we tend to see oil move higher. However, even with the big move this morning, crude oil is still well below $90/barrel at just over $86. Still, this is something worth watching as the recent drop in price has helped relieve some inflationary pressure.
There is a lot of talk about a flight to quality right now. Typically, a flight to quality sees bonds and commodities such as gold move higher. While gold is higher in premarket by almost 1%, bonds are up just 0.5%. The lack of move in bonds could be a result of concerns about inflation. It could also be because cash markets are closed today and when that happens, moves in the bond futures tends to be a bit muted.
Some individual stocks I’m keeping my eye on include Bristol-Myers Squibb, who announced they will buy Mirati Therapeutics for $58 per share. I’m also watching the defense stocks as a whole as I expect them to trade higher, at least on the open. I’m also watching automaker stocks. Progress was reported late last week on the current strike and no additional walkouts took place last week.
Finally, I want to talk a little about volatility and the concept of options skew. In premarket, the VIX is up nearly 9% and trading right at 19. While 9% is a big jump, 19 is not a big number and we could see volatility move higher if the war in Israel escalates further. Skew is something we see when markets perceive the volatility of risk in a specific direction. While skew can happen in either direction, it often helps define the perceived risk of a situation. It is merely the relationship of the volatility levels in puts vs. the volatility level in calls. What we are seeing here is something that I believe makes many nervous about downside risk. Therefore, you may see more demand from market participants for downside protection, that is buying puts. In fact, often to finance the purchase of these puts, those that are long the market, may sell calls, sacrificing some upside to cover the price of buying puts, or protecting the downside. You can see how the pressure on the upside to finance the downside changes the relationship between the calls and puts. I’ll highlight two things: First, hopefully you learned something and if you hear folks refer to skew, you have insight as to what they are saying. Secondly, by understanding this, you better grasp how and why people are hedging any black swan events that could be take place. As always, I would stick with your investing plans and long term objectives.
tastytrade, Inc. commentary for educational purposes only. This content is not, nor is intended to be, trading or investment advice or a recommendation that any investment product or strategy is suitable for any person.
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