Late Day Volatility=The leveraged and inverse ETFs have to go out and buy or short stock each day based on the demand for the shares

Late-day volatility explained

Tuesday, December 16, 2008

You may have noticed a trading trend in the past few months: All to frequently, the final hour of the trading day coincided with a big jump in volatility, with major indexes either plunging or soaring between 3 p.m. and 4 p.m.

You're not alone. The Wall Street Journal recently covered this topic, and Bespoke Investment Group actually crunched some numbers and came up with a theory about why this is occurring right now.

The numbers go like this: If the S[amp]amp;P 500 has been in positive territory for more than half of the day, the average gain in the final hour has been 1.04 per cent. That's quite a spike for one hour of trading. At the same time, if the S[amp]amp;P 500 has been in positive territory for less than 50 per cent of the day, the opposite occurs: The index has plunged by an average of 1.2 per cent in the final hour.

This is a fairly recent development. The average high-low spread of the S[amp]amp;P 500 – or the percentage difference between its high point and low point – between 3 p.m. and 4 p.m. was 1.8 per cent between June and December. But for November alone the spread was an amazing 3 per cent.

Bespoke believes the reason for this surge in volatility is the popularity of leveraged and inverse exchange traded funds – baskets of stocks that will deliver two- or even three-times the moves in their underlying indexes.

“The leveraged and inverse ETFs have to go out and buy or short stock each day based on the demand for the shares,” Bespoke said.

“If the market is trading lower for most of the day, the inverse ETFs are most likely having to short stock at the end of the day to match demand – hence lower prices from 3 to 4. If the market is trading positive for the majority of the day, the ultra long ETFs may be buying shares or the inverse ones are covering at the end of the day.”



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