With the exception of a couple of small hiccups recently, market selloffs have been few and far between since President Trump took office at the start of 2017.

Whether that trend continues through the end of 2018 is anyone's guess.

For volatility traders, it almost doesn't matter - we take what we can get. If implied volatility environment remains low in general, we can consider extending the duration of our trades, as outlined on a previous installment of Market Measures.

If the trading environment does shift beyond the recent tremors (finally!), the best action one can take is simply to be prepared for that development. That might mean trading small, and maintaining a nimble portfolio in the meantime. Or, that might mean identifying places you can go in the markets to hedge your exposure - if things take a turn for the worst.

In the spirit of being prepared for a bigger selloff, a new episode of Market Measures is well worth a few moments of your time. The focus of the show is "When Indices Fall." And while market selloffs are starting to feel like a myth, they most certainly are not. Don't let this year’s long periods of relative tranquility fool you.

The focus on Market Measures was to investigate historical data in stock indices to illustrate how implied volatility tends to behave when a selloff has materialized in the past. The wrinkle in this particular study was that the Market Measures team looked not only at SPY, but also QQQ, DIA, and IWM.

The goal was to compare the behavior of implied volatility across the spectrum of stock indices, and to reveal any patterns that might represent opportunities in the future - when, not if, the next selloff arrives.

For a full breakdown of this investigation, we refer you to the complete episode of Market Measures. In this particular post, we simply wanted to highlight the hard-hitting takeaways.

Summarized in the graphic below are the responses in implied volatility for each of the 4 primary US stock indices after a drop of 1%:

When Indices Fall

Looking at the data, we can see that SPY has historically experienced the biggest jump in implied volatility when SPY has dropped by 1%. QQQ, despite housing many of the more "volatile" technology-related companies, saw a slightly smaller bump in implied volatility during a 1% selloff.

This data should help you better understand the potential behavior of implied volatility when the next correction arrives. In turn, it may also help you better plan for how you might respond.

If you want explore more historical data related to corrections, we recommend reviewing this previous blog post "Further Analysis on Corrections" when your schedule allows.


Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.


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