The spread of COVID-19 has elevated volatility, following an economic recession that could be reignited. The United States has experienced the worst quarterly growth in its history in the Q2 followed by the best expansion in history in the Q3. The trend in the spread of the virus has been upward sloping, and in Europe, this has led to a lockdown in Germany, France, and the United Kingdom. A lockdown in the US would lead to a contraction in growth and this would eventually lead to lower stock prices and higher volatility. The VIX has also been heavily affected by the US election. Ahead of the results, the VIX remained elevated hovering near 37%, nearly 3-times the average seen during 2019.
Birx Warns of Record Spread
Internal White House staff has attempted to sound the alarm that the virus in the US is poised to explode. Dr. Deborah L. Birx, in a private warning, told White House officials that the pandemic is entering a new and deadly phase that demands a more aggressive approach. As the number of cases increased to nearly 100,000 per day, Dr. Birx felt she needed to sound the alarm, contradicting the President who continues to tell constituents at rallies that the US is rounding the corner. Dr. Birx suggested in the memo that the White House was spending too much of their time worrying about the lockdown and not focusing on controlling the virus.
The report warned against the type of rallies the President was having ahead of the General election on November 3. She also forecast that the US would see the number of COVID cases increase to more than 100,000 per day. Birx wrote that the country is “entering the most concerning and most deadly phase of this pandemic,” in a White House memo.
If Donald Trump wins reelection in the US, he is likely to ignore the continued spread of the virus and try to focus on economic solutions. If the virus reaches unsustainable levels, and there are targeted closes in large states, the markets will begin to sell off to reflect the potential lower growth and possible contraction in the US economy. If Joe Biden wins the election, he will begin a program to target the virus, and initially, the markets might sell-off. If there is a concrete plan on how to deal with the spread of the virus, the markets will look through the initial contraction of growth and potentially rally.
How will the VIX React
The VIX index reflects the implied volatility on the S&P 500 index. As premiums on options become more expensive that increase is reflected in higher implied volatility values which buoy the VIX. The reverse is true if option premiums begin to decline. Higher levels of volatility mean that options traders think the markets will move at a greater rate than the present. Volatility measures both downward and upward movements but historically as equity prices rise, implied volatility declines, and as equity prices fall implied volatility rises.
The VIX is a forward-looking indicator. If traders believe that the virus will spread and therefore it will generate a contraction in economic growth weighing on equity prices, the-VIX will increase. If the trend in the spread of the virus declines, economic expansion is likely helping to depress the VIX.
The Bottom Line
The spread of the virus will likely have a continued impact on the value of the VIX. With nearly 100,000 cases per day in the US, the VIX is elevated but well of the highs seen in March of 2020. If the spread of the virus is curtailed, options traders will likely sell the VIX pushing back to the lows seen in August.