Exploring the Impact of the Covid‐19 Pandemic on Derivatives Markets: Insights from Global Futures and Options Exchanges

Our investigation delves into pivotal shifts in trade-related activities across global derivatives markets amidst the Covid‐19 pandemic.

Decoding a Bear Market
A bear market materializes when a market undergoes prolonged price declines. It typically characterizes a scenario where securities prices plummet by 20% or more from recent peaks amidst prevailing pessimism and negative investor sentiment.

Bear markets are commonly linked with downturns in overall markets or indexes like the S&P 500. However, individual securities or commodities can also be deemed to be in a bear market if they undergo a decline of 20% or more over an extended period—usually spanning two months or beyond. Bear markets often coincide with general economic downturns such as recessions. They stand in contrast to the upward-trending bull markets.

Deciphering Bear Markets
Stock prices generally mirror expectations of future cash flows and profits from companies. As growth prospects dwindle and expectations falter, stock prices may witness a decline. Herd mentality, fear, and a rush to mitigate losses can contribute to prolonged periods of depressed asset prices.

One definition of a bear market suggests that markets enter bear territory when stocks, on average, plummet by at least 20% from their peak. However, 20% is an arbitrary threshold, much like a 10% decline serving as an arbitrary benchmark for a correction. Another definition of a bear market pertains to a scenario where investors lean towards risk aversion over risk-seeking. Such a bear market could persist for months or years as investors veer away from speculation towards safer, more predictable investments.

The triggers of a bear market often vary, encompassing factors such as a weak or slowing economy, bursting market bubbles, pandemics, wars, geopolitical crises, and profound paradigm shifts in the economy, such as transitioning to an online economy. Signs of a weak or slowing economy typically include low employment rates, diminished disposable income, sluggish productivity, and declining business profits. Additionally, any governmental intervention in the economy has the potential to incite a bear market.

For instance, alterations in tax rates or the federal funds rate might precipitate a bear market. Likewise, a dip in investor confidence could signal the onset of a bear market. When investors anticipate impending events, they are inclined to take action—such as offloading shares to mitigate potential losses.

Bear markets can endure for several years or just a few weeks. A secular bear market may persist anywhere from 10 to 20 years, characterized by below-average returns over an extended period. While there may be intermittent rallies within secular bear markets, where stocks or indexes surge for a period, these gains are often short-lived, with prices reverting to lower levels. Conversely, a cyclical bear market might last anywhere from a few weeks to several months.

The major U.S. market indexes nearly approached bear market territory on December 24, 2018, narrowly missing a 20% downturn. More recently, major indexes such as the S&P 500 and the Dow Jones Industrial Average (DJIA) plunged sharply into bear market territory between March 11 and March 12, 2020. Prior to this, the last protracted bear market in the United States unfolded between 2007 and 2009 during the Financial Crisis, spanning roughly 17 months, during which the S&P 500 lost 50% of its value.

In February 2020, global stocks plummeted into a sudden bear market in the wake of the global coronavirus pandemic, with the DJIA plummeting 38% from its all-time high on February 12 (29,568.77) to a low on March 23 (18,213.65) in just over one month. However, both the S&P 500 and the Nasdaq 100 surged to new highs by August 2020.

Phases of a Bear Market
Bear markets typically traverse four distinct phases:

• The first phase is marked by elevated prices and investor sentiment. Towards the end of this phase, investors begin exiting the markets to secure profits.
• In the second phase, stock prices commence a steep decline, trading activity and corporate profits start dwindling, and once-positive economic indicators begin to falter. Some investors begin to panic as sentiment wanes, a stage often referred to as capitulation.
• The third phase sees speculators entering the market, thereby elevating some prices and trading volumes.
• The fourth and final phase witnesses a gradual decline in stock prices. As low prices and positive news attract investors anew, bear markets gradually transition into bull markets.

“Bear” and “Bull”
The term “bear market” is believed to derive from the downward swiping motion of a bear attacking its prey. This analogy reflects the downward trend in stock prices during bear markets. Conversely, the term “bull market” might stem from the upward thrust of a bull’s horns into the air.

Bear Markets vs. Corrections
A bear market should not be conflated with a correction, which constitutes a short-term trend lasting fewer than two months. While corrections present opportunities for value investors to enter stock markets, bear markets seldom offer suitable entry points. This challenge stems from the difficulty in pinpointing the bottom of a bear market. Attempting to recoup losses can prove daunting unless investors engage in short selling or employ alternative strategies to generate gains in declining markets.

Between 1900 and 2018, the Dow Jones Industrial Average (DJIA) experienced approximately 33 bear markets, averaging one every three years. One of the most notable bear markets in recent history coincided with the global financial crisis from October 2007 to March 2009, during which the DJIA plummeted by 54%. The global COVID-19 pandemic precipitated the most recent bear market for the S&P 500 and DJIA in 2020. The Nasdaq Composite last entered a bear market in March 2022, amidst fears surrounding the conflict in Ukraine, economic sanctions against Russia, and soaring inflation.

Short Selling in Bear Markets
Investors can profit in bear markets through short selling, a technique involving selling borrowed shares and repurchasing them at lower prices. However, short selling entails significant risk and can lead to substantial losses if unsuccessful. Short sellers must borrow shares from a broker before initiating a short sell order. The short seller’s profit or loss is contingent on the difference between the selling price and the subsequent repurchase price, termed “covered.”

For instance, an investor shorts 100 shares of a stock at $94. As the price declines, the shares are repurchased at $84, yielding a profit of $10 x 100 = $1,000. Conversely, if the stock unexpectedly rises, the investor must repurchase the shares at a premium, incurring heavy losses.

Puts and Inverse ETFs in Bear Markets
A put option grants the owner the right, but not the obligation, to sell a stock at a predetermined price on or before a specified date. Puts can be utilized to speculate on declining stock prices and hedge against downward movements to protect long-only portfolios. Investors must possess options privileges in their accounts to execute such trades. Beyond bear markets, purchasing puts is generally considered safer than short selling.

Inverse ETFs are structured to move in the opposite direction of the index they track

. For instance, the inverse ETF for the S&P 500 would appreciate by 1% if the S&P 500 index were to decline by 1%. Numerous leveraged inverse ETFs amplify the returns of the tracked index by two or three times. Similar to options, inverse ETFs can be employed for speculation or portfolio protection.

Real-World Instances of Bear Markets
The ballooning housing mortgage default crisis spilled over into the stock market in October 2007. At its zenith, the S&P 500 soared to 1,565.15 on October 9, 2007. By March 5, 2009, it had plummeted to 682.55, reflecting the pervasive impact of housing mortgage defaults on the broader economy. The U.S. major market indexes neared bear market territory again on December 24, 2018, narrowly missing a 20% downturn.

Most recently, the Dow Jones Industrial Average entered a bear market on March 11, 2020, followed by the S&P 500 on March 12, 2020. This marked the end of the longest bull market on record, which commenced in March 2009. Stocks were driven down by the onset of the COVID-19 pandemic, ushering in mass lockdowns and apprehensions of diminished consumer demand. During this period, the Dow Jones plummeted from all-time highs near 30,000 to lows below 19,000 within weeks. From February 19 to March 23, the S&P 500 experienced a 34% decline.

Other notable instances include the aftermath of the dot-com bubble burst in March 2000, which eradicated roughly 49% of the S&P 500’s value and persisted until October 2002; as well as the Great Depression, precipitated by the stock market collapse of October 28-29, 1929.