Dori Levanoni
May 8, 2020

It is hard to believe we are just over a quarter into 2020. As the COVID-19 pandemic escalated, markets experienced their steepest selloff in history. Risk assets finally started to recover toward the end of Q1, after central banks and governments announced relief measures. That recovery has persisted into the early weeks of Q2, but many are questioning when (not if) the next risk event will occur. The options market can give us some sense of how options traders reacted to the escalation of the pandemic, and what may be in store for markets in the coming months.

Below, I use pricing from options on the S&P500 index to infer option traders’ outlook expressed as “risk neutral probabilities.”For those unfamiliar with the options market, these curves represent a combination of the likelihood of different future outcomes combined with risk aversion. When markets are stable, these surfaces look something like a bell curve. As you can see from Video 01, the surface looks fairly normal at the start of the year, becomes very distorted as volatility increases, and again starts to assume a more typical shape as stimulus packages are announced.


Sources: CBOE, CRB, Datastream, First Quadrant, L.P.

So where are we today? This kind of analysis can give us some sense of what option traders are anticipating. Figure 01 plots a “normal” distribution against the distribution observed on May 1, 2020.


Sources: CBOE, CRB, Datastream, First Quadrant, L.P.

This surface gives cause for both optimism and pessimism. On the bright side, options traders seem to be anticipating that markets will continue to recover. The curve peaks when the strike price is near 1.08, so the most likely outcome based on options pricing is a market rally of around 8%. On the other hand, though market conditions have improved since mid-March, we are not “back to normal.” The part of the curve on the down side is still concerning. The options market is pricing in a real probability that the market declines another 10% (or more) from where we are today.

Though markets are certainly more stable than they were a month ago, it looks as though it will take considerably more time for things to return to “normal,” in markets as well as life.


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© First Quadrant, L.P. 2020. Intended for Institutional and Qualified Eligible Persons Use Only. The views expressed are the views of First Quadrant, L.P. only as of the date shown and are subject to change without notice based on market and other conditions. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice, recommendation, or solicitation of any particular security, strategy or investment product. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of domicile. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

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