Signal2Noise (S2N) News
Posts
#225: Buckle Up Volatility is Here

#225: Buckle Up Volatility is Here

micksonmatch
February 04, 2025

S2N Spotlight

Things are moving fast; it is often best to take a deep breath and step back to compose oneself if you are feeling overwhelmed. We have heard enough about tarriffs, and we will hear a lot more from people far more knowledgeable than me. Trump never read the textbooks he writes them. We have a fair idea from his first term in office how wild things can get. Be prepared for a wild ride, so buckle up.

When I went to bed last night in Australia, the crypto markets were being murdered, and the S&P Emini was down more than -1.5%. When I woke up, the crypto markets were up on the day and most of the stock losses were reversed. We will look at the liquidation aftermath under the “Observation” section, but I want to “Spotlight” the volatility captured by the ATR (average true range).

I mostly work with daily close data, so if I looked at a typical volatility (standard deviation) calculation, it would not have picked up the wild swings during the day. The formula for the average true range is:

The range of a day’s trading . The true range extends it to yesterday’s closing price if it was outside of today’s range. TR=max[(high−low),abs⁡(high−closeprev),abs⁡(low−closeprev)]

I don’t want you to get stuck on the formula; any half-decent trading software will do the calculation for you. The point I am wanting to put across is that the ATR captures the volatility with various extreme points of the day often missed by classic approaches. Bitcoin was down at one stage over -10% and ended up 4% on the day. I show the ATR in 2 different ways, which also presents a whole new story. The green line shows the ATR in price, so there was a true range of 10,606, which is one of the highest readings in history. But price is a headline number; when a Bitcoin is $100k, price moves will be larger on average than when the price was $10k, so I stay away from looking at price ATR; when you look at the ATR% orange line, you cannot even see a spike, so this reading of 10.4% is pretty average. Moving along….

The story is not quite the same when looking at Ethereum. At one stage, ETH was down -27%. The ATR% was 32%, a pretty significant true range, but not something too unfamiliar thoughout ETH’s history.

Now for the $50 trillion dollar question. Yes, that is the market cap of the S&P 500. A 2.19% ATR is definitely worth noting, but we need to dive deeper.

The VIX index value quotes the expected annualised change in the S&P 500 index over the following 30 days, as computed from options-based theory and current options-market data. So as you can see in the VIX chart, we have been and continue to be in a range that doesn’t expect much volatility over the next 30 days. You need to be asking yourself, is that sensible?

Now is not the time to go into it in detail, but the low volatility is an artefact of a bullish market that is at all-time highs and has been trending up for many months, hence low volatility. Its just math.

This is where things start to get much more interesting, and I am kicking myself for not highlighting it sooner. Check the SKEW on the chart. Its not dirty talk; it is the market telling us that it is expecting wild things to happen. The higher the skew, the more expensive out of the money options are. The SKEW index highlights the perceived probability of a large negative market move, not captured by the headline implied volatility (VIX). This is the smart money insuring itself against injury or death.

I want to highlight that the US High Yield Bond Index (junk bonds) has a very strong correlation with the VIX. If you think the VIX is about to start getting more choppy, then the probability is good that yields are going higher.

Final piece of today’s puzzle. If the high yield index is inverted on its axis and overlaid with the S&P 500, you can see that a spike in high yields will see a drop in the S&P 500, in line with my general thesis that we are likely to see the S&P 500 year-end price lower than we are today.

S2N Observations

For a change in tempo, Tesla sales got crushed in California, its largest US market. I continue to wonder how this company maintains its lofty valuation. Elon gets stuff down, so it is not for me to pour water over his “ludicrous mode” statements about what Telsa the company will be. Beating against Musk has been a losing trade for many for a long time. If you think the markets are going to cool off, this is a high beta play to get some extra bang for your buck.

I was really happy to see Ross Ulbricht pardoned by President Trump from a lifetime prison sentence without parole. Ross was the founder of Silk Road, the notorious site on the dark web. Ross was/is a libertarian and did some really bad things; you should read American Kingpin (what a great book). I am a believer in second chances. I don’t know why I put myself through it, but I used to read his daily prison diary entries posted up to Twitter/X a few days delayed. It was so depressing but always made me feel grateful for what I have. Why am I discussing this?

Like me, Professor Dan Arielly has a fascination with the dark web. He recently was taken on a tour into the belly of the beast by a “pro”. I have never been on the dark web; the closest I have been was downloading Thor, the encrypted web browser, more than a decade ago.

Apparently only 4-5% of the world wide web (the internet) is visible to us. The dark web occupies about 1%. I was shocked but not surprised to read what Professor Arielly witnessed going on in front of his eyes.

Apparently yesterday was the largest liquidation day in crypto history. Liquidations are when the exchanges that offer margin trading liquidate a position because the price movement is likely to result in a negative margin, so they close you out automatically. This gives you an idea of how heavily leveraged the industry is.

This gives you an idea of the exchanges that got hit the hardest. not sure why Coinbase is not included.

I pulled these infographics off a site. However, the comments below seem to suggest this was far bigger than we realise.

On Monday, Bybit’s CEO Ben Zhou suggested that the recent crypto market correction might have resulted in the liquidation of up to $10 billion in capital, a figure that far exceeds previous estimates.

According to CoinTelegraph, this assessment came after more than $2.24 billion was liquidated from the crypto markets within a 24-hour period on February 3, as reported by CoinGlass. Zhou indicated that Bybit’s own liquidations accounted for $2.1 billion of that total.

Zhou expressed concerns that the actual total liquidations could be significantly higher than reported. “I am afraid that today’s real total liquidation is a lot more than $2 billion; by my estimation, it should be at least around $8 billion-10 billion,” he stated in a social media post on February 3.