The late August market selloff caused several measures of risk to perk up; now that markets have found a surer footing, it is worth checking up on some popular risk metrics.
1. Historical volatility: Right now, the look-back window for a one month SPX close-close volatility estimate and for the GJR-GARCH model includes the large market declines that occurred in mid-August. In the next few sessions, those volatile days will begin to fall out of the calculation window, and price-based estimates of volatility will decline. I expect SPX one month historical volatility to come down to about 8% by this time next week, assuming no large market declines in the coming week. In that context, short term puts priced at 16% and greater look positively rich.
S&P 500 Average 1 Month Stock Correlation
Source: Condor Options
2. Realized correlation: The average one month realized correlation of S&P 500 constituents rose to 63%, a level we've seen many times this year. If the risk scenarios that have recently occupied investors' minds really are unwinding, we can expect realized correlation to fall back towards 40%. The opportunity here is to take upside exposure in stocks with solid fundamentals where correlation to the index is historically high, on the expectation that such stocks should outperform as correlations fall.
S&P 500 Implied Correlation Indexes
Source: CBOE, Condor Options
3. Implied correlation: the news here is even more positive for investors. Implied correlation for the S&P 500 is already back to its lows for the year (which are also post-crisis lows). The January 2014 index will stop being quoted in several weeks, but the 2015 index has also fallen sharply as the market rallied this week. That's a good sign for stock pickers and fundamental investors, since it means the market expects individual equities to move on their own steam in the months ahead.
OptionsProfits can be followed on Twitter at twitter.com/OptionsProfits
Jared can be followed on Twitter at twitter.com/CondorOptions