Post Election VXEWZ Analysis

On Monday the Brazilian equity market reacted somewhat as expected to the re-election of Dilma Rousseff to another term as president of Brazil. When I say as expected, Rousseff is not considered very business friendly and her election resulted in about a 4% drop in the iShares MSCI Brazil Index ETF (EWZ).   This 4% drop was on top of EWZ being down 23% from the 2014 high as the election date approached and the equity market started to discount Rousseff’s re-election.

The equity market adjusted for the election victory, but one Brazilian oriented market hardly moved from Friday to Monday. That market was the VXEWZ futures. Last week, leading up to Sunday’s election and subsequent market reaction on Monday the spot VXEWZ Index was as high as the low 70’s. The index finished the week at 58.16 but as the market digested the idea of Rousseff in charge for another four years VXEWZ moved down over 26 points to finish Monday at 31.30.  The front month November VXEWZ futures contract finished last week at 27.75 and was down 0.35 to 27.40 on Monday – that’s a big contrast to the change in the index.  To illustrate the Friday to Monday price change the VXEWZ term structure from last Friday to this Monday appears below.

VXEWZ Friday - Monday


Note the big drop in the index while the futures hardly moved. The index indicated the implied volatility of options that were trading just before the election as traders put on speculative positions and investors may have hedged their Brazilian exposure. The futures on the other hand settle based on where 30 day implied volatility is at expiration. The November future was discounting much lower volatility as indicated by EWZ option pricing once the election was over. Those futures contracts are still at a bit of a discount to spot VXEWZ, but for the most part were a pretty good indication of the pending drop in implied volatility. I often like to emphasize that looking only at a volatility index and not including the futures markets will not tell you to whole story of implied volatility expectations. This past weekend VXEWZ and the respective futures pricing reemphasized that line of thinking.