Individual stock volatility reaches historic highs relative to index volatility.

Back in mid-February, we wrote about the concept of a “Rip Tide Market” to describe the high level of single stock implied volatility relative to that of the CBOE SPX Volatility Index (VIX) (read more here). We eventually saw SPX implied volatility catch up to what was going on at an individual stock level. The spread between individual stock implied volatility and index implied volatility eventually fell to washed out levels a few days before the bottom was established on the last trading day of the quarter. The recent rally in SPX has sent the VIX back to normalized levels below 20, however, single stock implied volatility is still very high on a relative basis. The current setup has led to the most intense Rip Tide Market in our data set with the spread between average SPX constituent implied volatility and VIX reaching the highest levels over the last two weeks. This doesn’t mean that the market must fall or experience a spike in volatility, but the conditions are ripe for a spike in index volatility.

Outside of raising cash, trimming heavily overbought or outsized positions, or moving away from high RS names to more defensive positions, there are ways to play a Rip Tide Market with options. Since SPX implied volatility is “cheap” relative to single stock implied volatility, buying index ETF puts would be one way to add portfolio protection. For the exact details on how to do that, you can read the article linked here. The second path that’s available to many advisors would be to sell calls on existing stock positions, especially those that are extended to the upside, since single stock implied volatility is quite high. Many stocks within the Mag Seven and semiconductor names like Micron (MU) that have had a large rally, lack nearby support, and high implied volatility would be ideal candidates if they are already within client portfolios. One could also combine these strategies into one trade by using the calls sold on individual stock positions to fund portfolio insurance via index ETF puts. This would also be a more fine-tuned trade on the spread between index and stock implied volatility contracting. Overall, investors should be at least a little concerned about the hefty level of individual stock volatility following such a strong move in the market.