Now that earnings season has passed and the oppressive heat of August is in full force, talk of the summer doldrums has descended upon Wall Street.
Some will tell you summer is where volume and volatility go to die.
Some would be right.
Trading patterns so far this month have certainly supported August’s low-volume reputation. According to WSJ Markets Data Group, Monday’s trading volume came in at a paltry 4.6 billion shares making it the lowest volume day of 2013.
The curious among us might be seeking plausible explanations driving the lull in trading activity. Well, chalk it up to cultural behaviors. When the warm weather beckons, investors depart their trading turrets and head to more inviting destinations like the golf course or the beach.
As for volatility, look no further than the CBOE Volatility Index’s (VIX) predilection to head south for the summer. In his book Options Volatility Trading, Adam Warner looked at the average levels of the VIX for each expiration cycle from 1990 to 2007. Not surprisingly, the June cycle (which covers most of July) and the July cycle (which covers most of August) boasted the lowest average VIX levels at 17.74 and 17.31, respectively.
Despite the market’s historical penchant for lackluster movement in the eighth month, during the past four years, August has been anything but a snoozer.
Interestingly, August has proved quite the mover and shaker of late. Time will tell whether 2013 follows in the volatile footsteps of recent years or toes the conventional line and delivers up a dose of dullness.
While the lower trading volume might not merit any drastic changes in your trading tactics, the lower volatility offers a few temptations.
In a low-volatility environment, demand for options dwindles, causing a noticeable drop in their prices. As option premiums shrink, the life of an option seller becomes increasingly difficult. To receive the same amount of profit, he or she has to sell closer-to-the-money options, which usually increases the risk of the bet.
The phenomenon of option-sellers becoming increasingly aggressive when a low-volatility regime takes hold is similar to the “reaching for yield” that occurs in a low-interest-rate environment. When the rate of return on investments like U.S. Treasury bonds, CDs and other assets lying well within the safe zone of the risk continuum fall to lowly levels, investors seeking more income are often tempted to “reach for yield.” Typically, this consists of plowing money into junk bonds, high-yield stocks, and real estate investment trusts (REITs) that offer higher rates of return, but also more risk.
If you’re selling spreads like iron condors and the barren volatility landscape is tempting you to move your short strike prices closer-to-the-money, just make sure you’re aware of the elevated risk. You might consider selling fewer contracts to compensate.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.