The death of the snake…
Volatility fires almost always begin in the debt markets. Lets start with what volatility really is. Volailitiy is the brother of credit… and volatility regime shifts are driven by the credit cycle. Volatility is derived from an option on shareholder equity, but the equity itself can be thought of as a perpetual option on the future success of a company. When times are good and credit is easy, a company can rely on the extension of cheap credit to support its operations. Cheap credit makes the value of equity less volatile, hence tightening of credit conditions will lead to higher equity volatility. When credit is easily available and rates are low, volatility remains suppressed, but as credit contracts volatility rises.
Here is a link to the full report.
This report confirms, much more eloquently, the points I have been making in the Subscriber’s videos regarding the factors contributing to low volatility, how positions are sized in automated trading systems and the influence high yield spreads are likely to have on market structure.
The Barclays High Yield Spread over Treasuries continues to make new lows suggesting the status quo which is contributing to the success of the short volatility trade is still intact. However, this is a chart I monitor on a daily basis because when we have evidence of a turn in the high yield sector it is likely to act as a lead indicator for the next recession which will certainly contribute to an uptick in volatility.