Non-Farm Volatility Compression

In Blog by Michael Arnold

More money is lost on non-farm payrolls trades than any other day. There are no hard stats to show you, but more retail options traders are buyers prior to non-farm payrolls than sellers and buying options means buying volatility (vol). Historically, price moves quickly after the payrolls numbers, but then vol comes down. This “volatility compression” eats away at option premium and requires the trader to be more right than a position entered during a low vol period.

Generally a retail trader picks a long or short position prior to the figure and price moves dramatically immediately after the release. There is the initial move, and then the market settles in as major market participants digest the data. A directional move then begins and with the release coming on the last day of the week, there is rarely anything left on that day for the market to be uncertain about. We often hear the VIX, which is the CBOE’s volatility index for stocks, called the fear index but like most market clichés, it’s wrong. It is really an uncertainty index. The “fear index” name comes from the regular rise in volatility when stocks fall, presumably due to people being afraid of further losses in their long stock positions. The stock market however, tends to have a long bias with people only looking for what they should “buy”. Traders and investors do not feel uncertainty when equity markets rise because they are conditioned to believe that they SHOULD rise. Therefore, a rallying stock mark makes one feel certain and a falling market makes one feel uncertain, hence the rise in the VIX during a falling stock market.

But back to the point; in the 90 minutes prior to today’s non-farm payrolls release, the E-Mini S&P 500© was locked in a 3 point range from 2037.25 to 2040.25. Immediately after the release, a new low was made a full 6 points lower, at 2031.25. Short-term traders then covered short positions and the market rallied back to 2036 and then began a slow and steady move lower to 2030.50 with volatility falling. If the trader was not perfect on direction, their option long or short has a strong probability of losing value quickly as vol collapses. Be careful in thinking that trading on the non-farm payrolls data is a great opportunity because of the price movement. It’s the effect of volatility, not price that you have to know about.

Futures, options and swaps trading involve risk and may not be appropriate for all investors. Past performance is not necessarily indicative of future results