Less focus on the Fed as a June hike appears off the table
- Fed likely on hold in June, UK referendum looms large
After a disappointing labor market report, the Fed is expected to stay pat in June. Last week’s selloff seems to be motivated by the upcoming UK referendum, as uncertainty around its outcome rises and assets most levered to it – GBP and GBP options in particular – are starting to flash red.
- S&P 500 options are pricing a 4% chance of a bear market over the next month
Although the VIX landed at 17 last week, 1m SPX implied volatility is still below its one-year median at 13.9 and the options market is pricing in a low chance of a risk-off event. S&P 500 digital options are pricing in a 4% chance for a -10% market decline over the next month, down from 10% on February 11th when the S&P 500 hit its ytd low.
The current probability of 4% is slightly below its median level back to 2005.
- Event Risk: Does the U.S. options market care about FOMC and BREXIT?
A look at SPX weekly options allows us to get a week-by-week breakdown for how the options market is pricing the June FOMC meeting and potential “Brexit” concerns. Excess hedging demand around specific expirations can create
identifiable “kinks” in the term structure of implied volatility. The SPX term structure is pricing the FOMC meeting as a non-event but a kink in the curve does appear around the UK referendum on June 23. The 1m-1w SPX term structure is now near a multi-year high.
- SPX skew at record highs across terms
Excess hedging demand drives up the cost of bearish put prices relative to bullish call prices and put/call option skew rises. After the increase in hedging demand last week, S&P 500 skew is now near a record high across terms.