Chart courtesy of TD Ameritrade
What's JCJ, you ask? OK, I had to refresh my memory, too. I remembered it was a correlation index that I used to sort of watch, but had questions regarding its methodology. Anyway, here's the description via the Chicago Board Options Exchange (CBOE):
The CBOE S&P 500 Implied Correlation Indexes are the first widely disseminated, market-based estimate of the average correlation of the stocks that comprise the S&P 500 Index (SPX). Using SPX options prices, together with the prices of options on the 50 largest stocks in the S&P 500 Index, the CBOE S&P 500 Implied Correlation Indexes offers insight into the relative cost of SPX options compared to the price of options on individual stocks that comprise the S&P 500.
Ticker symbols are JCJ, KCJ and ICJ are "rotated" as time elapses. For example, as of December 2012:
- CBOE began disseminating daily values for the CBOE S&P 500 Implied Correlation Indexes in July 2009, with historical values back to 2007.
- CBOE calculates and disseminates two indexes tied to two different maturities, usually one year and two years out. The index values are published every 15 seconds throughout the trading day.
- Both are measures of the expected average correlation of price returns of S&P 500 Index components, implied through SPX option prices and prices of single-stock options on the 50 largest components of the SPX.
- Jan 2014 maturity S&P 500 implied correlation
- Calculated using Jan 2014 equity options and Dec 2013 SPX options
- Quotation is suspended after the Nov 2013 SPX expiration
Ah, it's coming back to me now.
Correlation is a hugely important concept as it pertains to options. Index option volatility has two drivers: the volatility of each individual name, and the degree to which the names themselves correlate. The greater they correlate, the greater the volatility.
Clearly what we see now is the opposite. Correlation is tanking, meaning that everything is pretty much dancing to its own beat (relatively speaking). That has the effect of tamping down index volatility, as moves in some components offset moves in others. Apple Inc.'s (NASDAQ:AAPL) weakness in Wednesday's otherwise modest rally is a perfect example of low correlation impacting index volatility.
So the concept of these Correlation Indexes is sound, it's just the methodology I question in regards to their utility. They all fix the expiration date, so if you're looking at JCJ over time, for example, you're comparing apples to oranges. If you looked at JCJ this past January, you'd measure the implied correlation of one-year options. If you look now, you're measuring the implied correlation of four-month options. Perhaps implied correlation simply declines the nearer you get to expiration; perhaps the tank in JCJ does represent a decline in overall implied correlation. The point is that I just don't know.
I suspect it's a combo of the two. KCJ, which goes out to 2015, has declined too, though not as abruptly. To me this suggests overall implied correlation has dipped, but it's dipped greater the nearer you get to expiration. So it suggests at least part of the dip in JCJ is due to the fact that it simply measures something different than it did half a year and a year ago.
It's safe to say correlation has dipped, I just wouldn't necessarily worry that it's at alarming levels.
Disclaimer: The views represented on this blog are those of the individual author only, and do not necessarily represent the views of Schaeffer's Investment Research.