Attention shifts back to Corporate America next week. While a number of widely held names, like Alcoa ( AA), JPMorgan Chase ( JPM), and Google ( GOOG), have already released results, the floodgate on third quarter earnings doesn't begin until next Tuesday. Interestingly, volatility in the options market is falling ahead of the results and, while a lot of focus has been on macro trends in recent months, the third quarter earnings reporting season could bring along some long-awaited good news.
CBOE Volatility Index ( VIX) is down 1.05 to 29.65 today and now off 35% in less than two weeks. VIX has not closed below 30 for more than past two months and the dramatic decline in the market's "fear gauge" reflects a sharp decline in investor anxiety and risk perceptions seen during the past two weeks. VIX tracks the implied volatility priced into S&P 500 Index (.SPX) options and rallied to 45.45 on October 3 amid worries about the European Debt Crisis. Also, on October 3, the euro fell to 8-month lows against the dollar and decade lows on the yen.
The European debt mess continues to drive a lot of action in the US equity market and the S&P 500 has rebounded along with the euro and European equity markets since October 3. VIX has been falling during that time and, at 29.65, reflects expectations for lower levels of market volatility in the weeks ahead. Since VIX tracks implied or expected volatility, it is a forward-looking indicator. By way of comparison, the actual volatility of the S&P 500, which is based on previous closing prices, is 35.4% over the past 60 days. VIX is now 16.2% below the 60-day actual volatility.
Looking across sectors of the market, the difference between the expected volatility priced into options and actual volatility is even more striking. For example, implied volatility in the options of the SPDR Basic Materials ETF ( XLB), which holds all of the metal, chemical and other "basic material" names from the S&P 500, has fallen to only 22.6%. The actual volatility of the fund over the past 60 days is twice that, or 45.1%. (See Table 1 for a breakdown of volatility by sector). Since the options market is often very efficient in anticipating changes in market volatility, the falling levels of implied volatility across all S&P sectors could be signaling a return to more orderly market action in the weeks ahead - i.e. the extreme levels of market volatility seen in August and September will subside.