Short-Term Volatility and the Employment Report

Today begins a new month and that means one thing to traders, the employment number is just around the corner. Friday we’ll get the latest data from the Labor Department at 7:30 Chicago time. Depending on the number VIX and S&P 500 futures will jump in one direction or another. Also, everyone on the business networks will discuss what they think number means for the economy and the financial markets and traders will trade the reaction.

Along with quarterly GDP reports and periodic FOMC statements, the jobs reports ranks very high in importance for getting a read on the economy. This monthly employment situation report is significant for a few reasons. First, it is an early view on the previous month’s economic activity. Friday’s report will cover the employment situation in the United States for the month of September. Also, businesses hire based on what they perceive as a future need. Hiring can be seen as a positive for the economy based on current and anticipated business conditions. Finally, any inflationary pressures may show up first in the employment report. Some components of the report discuss labor costs and an increase in the cost of hiring or retaining employees may be an early sign that prices are about to rise.

We could almost say that the employment report is like a monthly earnings report for the overall economy. Option traders know that when a company is preparing to report earnings the implied volatility of those options will move up into the earnings report. If the employment report is an earnings report for the overall economy then the S&P 500 may be considered the underlying market. Putting those two things together we can say that near term implied volatility as indicated by S&P 500 (SPX) index option prices. There is no better measure of short term SPX volatility available than the CBOE Short-Term Volatility Index (VXST). This being said, I decided to take a look at VXST before and after employment reports.   The table below shows what the S&P 500 did on the day of the employment report along with VXST the day before and day after.

VXST Earnings

Notice that VXST has dropped on eight of the nine employment reports this year.  The number that was released on April 4th resulted in a big drop in the S&P 500 and a rise of 0.65 points for VXST.   Admittedly, the S&P 500 has been higher six of those nine reports, but even when there is a small drop in the S&P 500 VXST drops as well. It is a short history, but a telling one. If you are positioning yourself in short term SPX options before the number you may want to take into account the possibility of a drop in implied volatility this coming Friday. Even better you may want to take a look at VXST futures or options and see if those markets offer any opportunities based on your view of the market’s reaction to September’s employment situation.

More information on VXST can be found at www.cboe.com/vxstms