Volatility in U.S. stocks rebounds as some investors take profits on value rally

By April Joyner

NEW YORK (Reuters) - Brightening prospects for a COVID-19 vaccine and greater clarity on the outcome of the U.S. presidential election have not dimmed expectations for volatility in U.S. stocks.

The Cboe Volatility Index <.VIX>, known as Wall Street's "fear gauge," reversed course on Monday to end higher, at 25.75, after having reached its lowest level since August.

Data showing an effectiveness rate above 90% for Pfizer Inc's (NYSE: PFE) experimental COVID-19 vaccine sent shares in small-cap companies and in value sectors such as financials and energy soaring, while shares in technology-related companies lagged. The trading marked a departure from the long-standing trend of tech outperformance.

Yet stocks trimmed gains as some investors who had bet on such a rotation sought to take profits, analysts said. Likewise, many options investors closed positions that benefited from gains in such shares. The flurry of activity - leading to near-record trading volume in U.S. stock options - drove up volatility as a result.

"It was a pretty violent unwind," said Christopher Murphy, co-head of derivatives strategy at Susquehanna Financial Group.

Volatility could persist over the next week given heavy positioning in short-term call options, used to bet on further upside in stocks, according to strategists at RBC Capital Markets. An unwind of those positions could exacerbate stock moves, a phenomenon known as the "gamma effect."

Lingering political risk could also keep market participants on tenterhooks for the next few months. VIX futures show that volatility expectations appear relatively steady for the first half of 2021, but prices for most contracts stand near 25, compared to the index's long term average of 20.

Two January runoffs for Senate races in Georgia could determine whether Democrats or Republicans control that chamber. Democratic candidates Jon Ossoff and Raphael Warnock face an uphill battle against incumbent Republican Senators David Perdue and Kelly Loeffler. [nL1N2HU0GM]

Investors have embraced the idea of a divided Congress, which would make it more difficult for a Biden administration to push through tax hikes or increased corporate regulation. But should Democrats win both seats in Georgia, they could control the Senate with a tiebreaker vote from Vice President-elect Kamala Harris.

"The Senate being Republican-controlled is fairly important to the whole story for volatility," said Matt Thompson, managing partner at Thompson Capital Management.

Moreover, though Joe Biden has secured enough Electoral College votes to win the White House, President Donald Trump has not conceded and has put forth legal challenges to the election results. On Monday, Senate Majority Leader Mitch McConnell said he supported Trump's efforts. [nL1N2HV2GI]

A bumpy transition between White House administrations could also boost anticipation for volatility, said Amy Wu Silverman, equity derivatives strategist at RBC Capital Markets.

"With the markets exuberant today, I worry about the coming days, weeks and months," she wrote in a note to clients on Monday.

(Reporting by April Joyner; Editing by Tom Brown)

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