UBS Head of Equity Derivatives Research Stuart Kaiser joins Yahoo Finance Live to discuss how Tesla could impact the S&P 500 and weigh in on the auto company's overall performance this year.

Video Transcript

MYLES UDLAND: Let's talk a bit more about what's been going on in the markets of late. And joining us now for that conversation is Stuart Kaiser. He is the head of Equity Derivatives Research over at UBS. Stuart, great to talk with you this morning. I'd love to begin in the area that we don't often talk about on this show, but certainly investors are watching quite closely.

And that's the VIX and the role that it plays in the market overall, the role it's certainly played during this crisis. And now with the VIX near 20, what is that-- I guess, that's a level we've been looking at, to some extent, here. Jared Blikre does the technicals for us at Yahoo Finance. What does that level, to you, mean about the state of the market as we look out to 2021?

STUART KAISER: Good morning, and thanks for having me. Look, you know, the VIX getting down to 20, I think, has obviously caught a lot of headlines. I think it reflects, you know, two basic things, frankly. It's just that the markets rally pretty significantly and that realized volatility over the last couple weeks has been quite low. The point we've made, though, is that even though the VIX is at 20, the VIX futures, you know, beyond January are still around 25.

So the volatility market, I think, is telling you that, you know, recently, we've had very strong market performance. But there's still a lot of underlying risk out there in the market that it's quite aware of and quite sensitive to. And until we, you know, start to see that volatility a little bit further out the curve, so in the three to six months base, start to come down, I think that means the market is still a little bit on guard.

I think the positive side of that is it does suggests that there's still a little bit of risk premium out there in equity markets. So even though markets have rallied, there still could be a risk premium compression, which, all else equal, would be positive for the performance of the S&P 500, for instance.

MYLES UDLAND: And then, I guess, in thinking about a return to the regime that prevailed, you know, let's call it 2017, 2018, where we had, you know, low double-digit VIX-type levels, that was really the defining feature of the market in many ways. You know, what steps would you need to see to start thinking about that as a framework for the market? Because I think, right now, you still need to be on guard for 2%, 3% moves either direction.

STUART KAISER: You know, it's a great question. You know, 2017 and 2018, I think, were pretty unique from each other as well. You know, 2017 was, I think, one of the lowest volatility years we've had for the S&P 500 since-- in 50 years or so. So I think, you know, getting back to 2017 is going to be a little bit of a heavy lift. You know, 2018 might be the better comparison in the sense that volatility was low, but you still had one or two events where the market drew down pretty considerably because there was a fair amount of uncertainty in the market.

And, you know, to some degree, 2021 might feel a little more like 2018, where volatility is declining in between these sort of, quote unquote, "events," the market behaves very well in low volatility. But you still have some things going on. For us, 2021, at this point, you know, once we get past the Georgia runoff, which the market is pricing as a reasonably sized, you know, political event, you know, we would expect implied volatilities to decline post that event.

But still further out, kind of into the second half of 2021, we still think that that risk premium or that additional kind of concern for the markets is going to be a little bit sticky and take a little while to come down. Because even though the vaccine has been announced and the efficacy rate was a huge surprise, you know, it still needs to get distributed. It still needs to be taken twice. There's still enough uncertainty out there, you know, that we think risk markets are going to be a little bit cautious.

And equity investors, even though they've been very bullish the last couple of months, are still going to be, you know, just a little bit on edge in 2021, given the scar tissue and the muscle memory we've had from what's happened this year. One thing we've been highlighting, for instance, is, like, 12-month S&P 500 puts. So the cost to hedge yourself out for the next year are still exceptionally high. And that put option would generate you more than twice the S&P 500 dividend yield, for instance.

And I think, in a nutshell, that shows you that even though things are much better and market dynamics are much improved, the options market is not quite as complacent, perhaps, as the price action at the index level would indicate.

BRIAN SOZZI: Stuart, should investors expect really wild swings in the S&P 500 once Tesla's added?

STUART KAISER: You know, our view is that, at the index level, it won't be a huge impact. We went through the process of saying, you know, what would S&P 500 realized volatility have been had Tesla been a member for the last couple of years? And frankly, the impact was, you know, 0.1 vol points. It was a very small impact. And the largest it got was less than 1 percentage point of volatility.

So at the index level, we don't think it's going to be as big an impact on volatility. How it impacts sector per-- I mean, sector or index performance, though, you know, might be different than that. If you look at consumer-- the consumer discretionary sector, for instance, if you would have had Tesla as a member of that sector this year, that would have had a fairly significant impact on the realized volatility of the sector. It would have increased it by about a point and a half, and at some points, as much as 6 points.

And just for reference, that's on a base of about 25. So it could have a very significant impact at the sector level. Though, we don't expect it at the S&P 500 level to be disruptive, from a volatility perspective.

JULIE HYMAN: And Stuart, sort of a market mechanics question around Tesla. We keep hearing about how much money is going to move around that rebalancing. I'm curious how much is happening in advance through options. If you were seeing any of that activity on the part of institutions as they setup for that index change.

STUART KAISER: It's a great question. And, you know, I've seen a lot of estimates out there in terms of the rebalancing. I think the positive news is this was pretty well flagged. You know, there was some discussion that Tesla would get added earlier in the year. And they preannounced the addition this time. So hopefully, fund managers have had enough time to at least begin to get themselves rebalanced into it.

It's also been a very popular thematic stock. So you may have a lot of investors that have owned this outside of benchmark anyway. So, you know, could it be disruptive? A bit, I guess it could be. But I think, in this case, the fact that it's so well flagged and this has been such a popular, quote unquote, "theme stock," hopefully, it wouldn't be so bad. From an options perspective, all of these large cap tech stocks, whether they be Google, Amazon, Tesla, Facebook, are very, very popular from an options perspective, both retail accounts as well as institutional accounts.

So, you know, you've definitely seen, at periods of time, a lot of options flows into those stocks. I'm not sure if those are to rebalance or if that is just your sort of natural high volume large cap tech stuff we're seeing on the option side. So I think my answer to there would be we've probably seen a bit of it on the option side. I think we've probably seen a significant amount of it on the cash side.

And if you put those two things together, hopefully, the addition later December will be a modest impact as opposed to something that's a little more disruptive, especially since that does get you pretty close to the holiday,