Jhe Nasdaq-100 (NDX) had quite a ride in February. At the worst time of the month (February 23), NDX was down 9.5%, but managed to end strong with a loss of around 4.6% for the month. In the last three trading sessions of the month, NDX is up 5.4%, so momentum may push NDX to higher levels and 2022 may not be the disaster some have claimed in due to a combination of inflation, Fed action (or uncertainty), and many geopolitical issues that keep popping up.
NDX Options Market
The NDX put/call ratio showed less market concern in February compared to January. Note the heavy use of NDX puts on the left side of the chart, where market concerns have resulted in higher relative put volume to call volume. February activity was more balanced with a put/call ratio of 1.14 on average in February compared to 1.48 in January. For perspective, the same number for SPX was 1.73 in January and 1.67 in February.
VOLQ vs realized volatility
February was the second month in a row that NDX realized volatility was higher than VOLQ expected on the last day of the previous month. On January 31, VOLQ closed at 26.46 while realized volatility (quoted as a whole number for an apples-to-apples comparison with VOLQ) came in at 32.43. This follows a similar result for January where VOLQ closed at 6:00 p.m. on December 31 against a realized volatility result of 28.84. The graph below shows the realized volatility VOLQ – NDX by month from January 2014 to February 2022.
The long reddish lines represent the months where VOLQ significantly underestimated the realized volatility thereafter. Needless to say, the long red line, where the achievement was almost 50 points higher than the VOLQ, was March 2020, when the pandemic had the greatest impact on both financial markets and our daily lives. Finally, I would be remiss if I did not point out that there were several consecutive three-month occurrences where the realized volatility of NDX was higher than what VOLQ had predicted on the last day of the previous month. We all know that volatility is an average measure of return, sometimes it just takes us longer to get back to a normal environment.
VOLQ vs. VOLQ Futures
VOLQ futures, listed on the CME Group, have started to see an increase in volume. Volatility and options traders will use volatility futures prices relative to the spot index to interpret the market outlook for the respective volatility index and, by association, the underlying market. We calculate a weighted VOLQ futures contract using the first two months’ contract prices in what we call a modified futures price. A modified future takes the first two months and aims for a 30-day outlook by weighting the time of the contractors. The graph below shows this pricing on a daily basis for 2022.
The blue line, representing the VOLQ futures market, is at a premium to spot VOLQ when the curve is in contango. Spot VOLQ with a premium to the future price indicates backwardness, a state that usually accompanies excessive market uncertainty. So far, 2022 has been a matter of uncertainty, with backwardation showing 12 of the 39 trading days and contango being in place for the rest of those days.
During the first 18 trading days of February, the VOLQ remained high against the VIX. The two crossed paths on the last trading day of the month. This is one of the reasons I like to look at average volatility over a period of time versus numbers like monthly closes. VIX on sale on the last day of the month doesn’t tell the whole story of February.
This is an anomaly as February is usually a month when VOLQ is discounted to VIX on the majority of trading days. The following graph shows the average number of days VOLQ is closed with a premium over VIX by month. Note February, highlighted in blue, is generally lower than VIX.
The high VOLQ in February created opportunities to initiate wide margin credit spreads. For example, on February 1, a trader sold 100 NDX on February 18.and 13800 puts for 83.00 and bought 100 NDX on Feb 18and 13500 Puts for 58.20 taking a credit of 24.80. This trade was executed with NDX at 14895 and the gain at settlement appears below.
This trade was safe as long as NDX did not drop 7.4% over the duration of the trade. Note that the low highlighted on the earnings chart is approaching, but not exceeding the short strike of the sell spread. An analysis of the volume and the trade leads me to believe that this trade was held to expiration resulting in a profit equal to the credit received upon execution of the trade.
VOLQ remains at high levels, which is warranted given that realized volatility for NDX is close to 30 so far in 2022. However, NDX caught a tailwind to end the month and VOLQ rose below VIX. Predicting anything in the world these days is a risky prospect, but a continued recovery may begin for NDX.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.