Thursday, May 27, 2010
The euro financial panic appears to be easing. Swap spreads are off their highs, and the implied volatility of equity options has dropped from a recent high of 48 to 30 today. This should allow substantial improvement in equity prices going forward. Europe hasn't solved its problem, but the market response to the problem has, in my view, been exaggerated. Our inefficient markets just don't have the liquidity and the transparency that's needed to keep volatility (and panics) at bay. The price of inefficiency is excessive volatility (and lots of sleepless nights). That's unfortunate, but the solution is not difficult: as the market better understands this weakness, natural market forces will be brought to bear on the problem. More and more investors will become willing to buy dips and sell rallies, and more and more will be willing to sell put and call options (both being equivalent strategies). Over time this will serve to dampen volatility, and it will help buy time until eurozone authorities figure out an intelligent response to the threat of banking system insolvency.
Posted by Scott Grannis at 9:19 AM