2 Ways to Beat Low-Volatility Conditions

03/12/2012 3:30 pm EST

Focus: STRATEGIES

John Netto

Author, The Global Macro Edge

In curious low-volatility conditions like the present, John Netto suggests either a premium-selling approach or gravitating toward faster-moving markets like oil or world currencies.

Traders love volatility, but what do you do when there’s low volatility? Our guest today is John Netto to talk about where he sees the opportunities. So John, volatility is the lowest it’s been in a long time. What are you thinking here?

Well, I think we want to provide some historical context of how low volatility has been. Realized volatility is below 9%, meaning the S&P for the last month and a half has traded in an average annual range of 9%. The last time that we’ve seen the S&P trade in the range of 9% following a period where it traded in a 33% range—which is what it did last year—was 1928.  

So from that context, we haven’t seen this kind of low volatility following high volatility in over 80 years.

So when we see a market like this, you have two choices as a trader: one is to adjust your strategy and continue to sell premium and put in more of a short-Gamma strategy; or two, find other markets that provide an opportunity for price discovery, and I’ve been taking more of the latter than the former.

Alright, so what other markets are you finding this price discovery in?

Well, we could take a look at the euro right now. Take a look at gold, some of the metals, some energy. Crude gives more intraday and has also given opportunities as well.

Or, if you are going to trade the S&P when it’s a low-volatility environment, simply buy the dips. If we get a 2% or 3% sellback over a couple of days, step in and buy the dips, and until the underlying metric which we have fundamentally changes, that strategy should continue to provide opportunities.

Alright, so we’ve had a rally here in the first part of 2012, but with relatively low volume and low volatility. Is it a concern for you, or do you think the market is getting complacent here?

Well, the market is definitely getting complacent, but it’s also telling me that there are some really strong fundamentals, and we’ve dealt with a stock market for the last 11 years which really has gone nowhere. Equities have delivered horrible returns for the last 11 years, and now we see a lot of people doubting what we currently have.

Fundamentally—and I don’t play a whole lot of fundamentals—but we’re dealing with the S&P at the lower end of the valuation range with a P/E ratio sitting near 14 or 14.5, and if you look at what can happen here, if we were to continue rallying, it would catch a lot of people underexposed and flatfooted.

I say, though, what’s going to also benefit from risk appetite? So, look at the Aussie dollar out there, a very positive carry trade. I think gold is continuing to rally. Copper is a big play. We see China’s central bank has come around and lowered the reserve ratio requirement again.

So if you want the bang for the buck, the S&P is not the place to do it, but I think long Aussie dollar and long positive carry currencies as long as the global central banks are being very accommodative with their policy.

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