Whoever needs more proof that fear in the markets has subsided should take a look at the current front-month, at-the-money straddle on S&P Depository Receipts (NYSE: SPY) versus a similar straddle at the end of last year, around the time when the CBOE SPX Volatility Index (VIX) was still hovering around 60%. 

Currently, the SPY is trading for around $93. So the current front-month, at-the-money straddle is the 93-strike. The call is currently trading for approximately $1.70 and the put is trading for approximately $1.75. Recall that we use the term straddle when an investor buys or sells both the call and the put in the same month as part of the same transaction. In this case, the straddle is trading for $3.45. The breakeven prices, for someone who sold the straddle, are $89.55 and $96.45. So the options market is suggesting that as the likely range of possible prices for the SPY at July expiration in two weeks. 

Looking back at the December SPY options, we can see just how much more volatility was priced into the market. In early morning trading on Tuesday, Dec. 9, the SPY Dec. 91 straddle traded for $7.25. This is effectively the same straddle as we are seeing this month, with about two weeks to go before expiration, except the straddle closed at $7.25. So in December, the SPY at-the-money straddle had a price of 7.9% of strike ($7.25/$91). Today, the straddle is priced at 4% of strike ($3.45/$93). From this decline, we see how risk premiums have contracted since December. Today, the VIX is around 25.5% compared to 35% in May. Back in December, the VIX was around 58%.   

Here’s a practical example of what it looks like when people say volatility is declining and signs of increased risk-taking are becoming more apparent. Going into the holiday weekend, the VIX is inching back to the levels we saw before Lehman Brothers declared bankruptcy. That could show more risk tolerance, or it could simply show that traders tend to make smaller and fewer bids before a long weekend. The markets are clearly not back to the levels of last summer, but the SPY at-the-money straddle is a clear sign of just how much risk premiums have declined since December. It’s plausible that the market will return to the higher implied volatility levels of December, or even November. But for now, expected market moves (as measured by the SPY straddle) are at their lowest levels in months.  

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