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Equity trading: New challenges for vol and correlation traders

Recent equity market upheavals are presenting new challenges and opportunities for volatility and correlation traders. With the downturn in markets that kicked off at the end of February came a massive jump in short-dated implied volatility. The Chicago Board Option Exchange’s Vix index, which measures the implied volatility of S&P 500 index options and represents the market’s expectations of volatility over the next 30 days, jumped almost 80%, increasing from about 10% to 18%. Volatility in other major equity markets, such as the Eurostoxx, also jumped, as did equity market correlation. The 30-day realized correlation level on the Eurostoxx 50 doubled from just under 20% to 40%. Immediately before the downturn, volatility and correlation had been trading at historically low levels.

This presented investors with the opportunity to buy short-dated volatility at what suddenly looked like very cheap levels. "At the start of the sell-off we saw March implied volatility levels whip up from a very low base, but we didn’t really see much contagion on the longer-dated months," says Pete Clarke, equity derivatives strategist with Citigroup in London. After a few days of market turmoil the bid levels on volatility at the longer end of the curve also started to go up, but not nearly as much as those at the short end.

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