12.21.17 - 2017: A Year for the History Books

"Each time history repeats itself, the price goes up."

- Ronald Wright, author

The Financial Times recently analyzed volatility and determined that the last low volatility environment similar to the one we are in now was following the Kennedy assassination in 1963. That was 10 years before the introduction of options trading in 1973!

Now, almost 55 years later, the options market provides an important mechanism for managing risk and, yes, even generating alpha in a low volatility environment.  In particular, backtesting is a critical tool in a low volatility environment. As the perceived risk-to-reward of certain strategies become more marginal—even within simpler strategies such as covered writes—having data that can support better trade placement is valuable.

Even though there is no option data for the comparable low vol period of 1963, Hanweck’s 2+ petabyte archive of historical options data has deep history for prior periods that are long bull/low volatility environments. This includes full OPRA data back to 2006, another year of low volatility. Our historical options data offers a fully adjusted view for corporate actions to allow for apples-to-apples comparison and is accessible via file or database, local or cloud based.

There are several Use Cases for historical options data depending on where you sit in the options ecosystem:

> Market Makers/Traders:  Use historical options data for back-testing a calculation engine or refining a pricing model. Integrate with real-time data to calibrate model parameters.

> Brokers/Sales Desks:  Scan the market for ideas in trading trends and developing signals to present to clients.

> Software vendors/DMA Providers:  Deploy historical tick or high quality derived data to enhance applications and analytics (e.g., charting, technical studies).

> Automated Trading and Execution Researchers: Validate and back-test trading models and execution algorithms. Even stock-only trading can leverage option volatility patterns.

> Execution Services/Order Routers:  Analyze market liquidity at the tick level across competing market venues.  Discern evolving execution trends and detect changing risk profiles.

> Exchanges:  Assess impact of fee models and levels. Understand liquidity landscape across instruments, sectors, selected exchanges, or the entire industry.

> Compliance Officers:  Use full historical options tick data for surveillance or time, sales, and quotes queries. See full market context, before, during, and after transactions of interest.

> Risk Managers:  Leverage a high quality source of daily and intraday market data and analytics for stress tests and risk models.

In the current low volatility environment it seems easy for investors to fall asleep at the wheel. A recent case of this is Mattel ([stock symbol=MAT]), where even during a period where the stock price declined roughly 50%, participants in both the credit market and equity option markets seemed relatively sanguine on the firm’s prospects. Credit spreads (CDS) were steady to narrowing through most of 2017 (see CDS chart below).  Option Implied Credit (equity derivatives based), interestingly paralleled the credit view until approaching October when some unusual volatility started translating through from equity options even before credit spreads showed a marked change (see Hanweck Implied Credit chart below).  All these spreads soon widened considerably. Then after the market had already repriced there were the expected rating agency downgrades, and stories such as, “Mattel Thrown on Junk Pile; $3 Billion May Join High-Yield Index”. [1]

Chart 1: Hanweck Implied Credit Spread (Mattel)

Chart 2: CDS Spread (5 Yr Mattel)

The long-term chart on option implied credit spreads gives perspective on the magnitude of these changes and the extreme level of distress presenting in Mattel right now, with synthetic credit spreads back to levels not seen since 2009. The long-term view also reveals the relative instability of Mattel daily Implied Spread levels in 2017, even before the levels departed from the medium-term band. Long-term data series can provide important perspective that complements real-time data that may offer only the briefest of warnings, and needs to be interpreted rapidly.

Chart 3: Hanweck Implied Credit Spread, Long-Term View (Mattel)

As we close the book on 2017, here’s to a wonderful New Year. May your glass of volatility overflow!

[1] Source: Bloomberg Intelligence.

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