The last time the VIX was below 40.00 was on October 2, 2008
Wednesday, December 31, 2008
In 2009 investors will be scanning the globe for signs of economic recovery or deterioration. Among the many tools they should be watching in order to gauge the strength of global trade is the Baltic Dry Index (BDI.) The Baltic Dry Index measures shipping rates for dry bulk carriers that carry commodities such as coal, iron and other ores, cocoa, grains, phosphates, fertilizers, animal feeds, etc. In short, the BDI is an excellent proxy for global trade.
In the chart below, note how the BDI peaked after the S&P 500 index did in 2007 and bottomed after the SPX last month. The BDI may not be a leading indicator, but it is an important way to confirm whether moves in global equities are being reflected in an increase in global shipping. If the BDI fails to rally in 2009, be skeptical of any rally in stocks.
Tuesday, December 30, 2008
The last time the VIX closed below 42.00 was way back on October 1st, when the VIX closed at 39.81.
Before anyone gets excited about the possibility of the VIX back in the 30s, I should note that the VIX futures continue to reflect expectations of a rising VIX over the course of at least the next 2-3 months. Today’s VIX January futures settled at 44.18 and the February futures settled at 45.08. Futures for August through October are now priced in the 37-38 range, however, suggesting that volatility expectations are being lowered for the second half of 2009.
Here are the top posts of 2008, based on the number of unique readers:
- Ten Things Everyone Should Know About the VIX
- Prediction: Direxion Triple ETFs Will Revolutionize Day Trading
- What Is High Implied Volatility?
- Volatility History Lesson: 1987
- VIX November Futures
- The VIX, VXV and Volatility Expectations
- Strong Bear Signal from VIX:VXV Ratio
- Arms Index Going Back to 1992
- VXO Chart from 1987-1988 and Explanation of VIX vs. VXO
- The VIX-SPX 30 Day Historical Volatility Spread and Performance
- The Fallacy of the Bearish First Five Days
- Fear and Flight to Safety
- Overview of the U.S. Volatility Indices
- Rare Batman Pattern Forming in the VIX
- The Evolution of the Volatility Index Family Tree
- Can Markets Bottom Without a VIX Spike?
- VIX Numbers and Overbought Signals
- The Significance of Double Tops in the VIX
- VIX Spikes and the 2002 Market Bottom
- Equities or Commodities?
- SPY Put Volume Study
- A Long-Term View of the Put to Call Ratio
- The Rising Popularity of XLF Options
- ISE Implied Volatility Charts
- Is the Fear Bubble Bursting?
For those who may be interested, last year I compiled a similar Top 25 Most Read Posts of 2007.
Monday, December 29, 2008
Further to this morning's ISEE Put to Call Ratio at Highest Level in 16 Weeks, the ISEE equities only call to put ratio finishes at 198 -- the highest close since May 16, 2008.
The last time this index had back to back closes this high was 12/28 and 12/31/07.
It is worth noting that the only other year for which the ISEE equity only data is broken out is 2006; that year also had some higher than normal readings on the last four trading days of the year.
Given the brief holiday track record of the ISEE, my suggestion is not to dismiss the ISEE equity only data out of hand, but to take it with a grain of salt.
Trading is light so far and extreme values in the ISEE have a tendency to revert to the mean (146) as the day wears on, but coming on the heels of Friday’s high number, I believe the ISEE numbers should bear watching throughout the day.
For the record, the last time the ISEE equity call to put ratio was over 200 in a single session was back in the middle of May. At that time, the markets were just in the process of putting in a post-March top.
[source: International Securities Exchange]
Sunday, December 28, 2008
Now that the VIX is down more than 50% from its October peak, it seems as if everyone wants to talk about the VIX and volatility.
So…for the last time in 2008, here are some of the recent posts from around the blogosphere (with a heavy volatility flavor) that I have been chewing on for the past week or so:
- Credit Crisis – Signs of Progress (Prieur du Pressis, The Big Picture)
- Madoff’s Volatility (Felix Salmon)
- More Leverage (Adam Warner, Daily Options Report)
- Air Pocket Watch: November Hotel Occupancy (Paul Kedrosky, Infectious Greed)
- 2009: Already Looking Bleak (Mike Shedlock)
- Friday Market Sentiment (Headline Charts)
- Learning from Mistakes: The Short Sale Ban (Jeff Miller, A Dash of Insight)
- Spot the Difference in Volatility Levels (Peter Jacobson, Barron’s)
- The Relativity of Volatility & 100 Year Floods (Babak, Trader’s Narrative)
- The Volatility of the VIX: From Bear Panic to Barely Elevated (Brett Steenbarger, TraderFeed)
- Sentiment Surveys and the VIX (Peter Birchler, Stock Market Alchemy)
- Volatility, The VIX, S&P 500 and High Jump (Ian Woodward)
- Good Economic News for the Holidays: Volatility is Down (Ian Ayres, Freakonomics)
- Research Brief: Looking for Clues in Economic Volatility (James Picerno, The Capital Spectator)
- The Demand for Risk and a Macroeconomic Theory of Credit Default Swaps: Part I (Charles Davi, Derivative Dribble)
- Ideas for Volatile Times: Upside-Down Split-Strikes (Brian Overby, The Options Insider)
- Testing a Simple Index Covered Calls Strategy (CXO Advisory Group)
- International Long-Term Interest Rates (Bespoke Investment Group)
- ThinkorSwim ThinkAI (Emini Addict)
…a series of posts triggered by a Bloomberg article by Jeff Kearns and Michael Tsang’s VIX Fails to Forecast S&P 500 Drop, Loses Followers:
- Journalists Have a Responsibility Not to Get It Wrong (Mark Wolfinger, Options for Rookies)
- VIX Fails to Give You a Pony and Premature VIX Obituary Roundup (Condor Options)
- Bloomberg Says VIX Is Worthless (Don Fishback)
- VIX Searching for Its Mojo (Adam Warner, Daily Options Report)
…and VIX and More’s first mention in Barron’s:
- The Best Way to Use the VIX (Michael Kahn, Barron’s)
Saturday, December 27, 2008
In a week in which most securities drifted lower on uninspired volume, gold was a notable exception, jumping 4.1% as tensions between India and Pakistan increasingly point toward the possibility of a military confrontation while violence in the Gaza Strip between Israel and Hamas is escalating.
Against the backdrop of potential conflict in either Gaza or the India-Pakistan region, gold surged above the critical 840 mark and ended the week at 871. As the uppermost of the two dashed black lines in the chart of the week shows, resistance from previous November-December 2007 highs was pierced this week. Gold also broke out of a down trending channel (solid black lines) this week and is now setting up for a possible large bullish move. If gold continues to rise, look for gold miners (GDX) to be even more volatile and likely outperform the commodity or the popular gold bullion ETF, GLD.
Friday, December 26, 2008
There are quite a few ways in which to measure historical volatility. Probably the most responsive of the time periods commonly measured is the 10 day historical volatility (HV) period, which covers the last 10 trading days. Variously referred to as statistical volatility, realized volatility, actual volatility, etc., the 10 day historical volatility measure for the SPX (dotted blue line in chart below) peaked on October 22nd at just a fraction under the 100 level. On December 3rd the 10 day HV was still holding strong at 89, but it has fallen precipitously over the course of the last three weeks and is down to just 35 as of Wednesday’s close and on target to dip as low as 33 or so today.
For comparison purposes, the 10 day HV in the SPX has not been below 35 since September 12th, just prior to the Lehman bankruptcy.
The bottom line: while a VIX in the low 40s may look cheap at the moment, consider that the recent historical volatility in the SPX has been slightly more than three quarters of that represented by the VIX. Of course, the December holiday effect has artificially depressed volatility to some extent, but certainly cannot claim full responsibility for the drop in 10 day HV from 89 to 35.
[source: VIX and More]
Wednesday, December 24, 2008
Two years ago, when I was the only person reading this blog, I posted about VIX seasonal patterns in A Month By Month Look at the VIX. Since the original post I have received quite a few requests to update the chart with more recent data.
On the heels of yesterday’s VIX Holiday Crush, I am pleased to broaden the seasonal picture of the VIX with a current version of 19 years of VIX data as a composite annual cycle. The chart below has changed very little from the January 2007 version. In fact, 2008 followed the historical patterns established in previous years almost perfectly, with the VIX increasing in the January-March period, dropping through May and June, then spiking dramatically in September and October.
I have my doubts about whether this pattern will play out in future years, but the more times volatility wanders down this same seasonal path, the more time traders will be looking for a repeat in the following year.
[source: VIX and More]
Tuesday, December 23, 2008
The VIX has been steadily declining during the month of December, from the high 60s on the first day of the month to the neighborhood of 42 as I write this.
Clearly the extraordinary measures taken by the government to pump liquidity into the system have been responsible for some of the shrinking volatility, but since I often talk about the holiday effect on volatility and frequently receive questions on the subject, I thought it would be a good day to share some of my research on the subject.
Since 1990, the month of December has averaged 21.05 trading days. The chart below captures each of those 21 trading days from 1990-2007 in composite form, with the mean for all December VIX values set at 100. In the chart, the pattern of decreasing volatility is most evident from the middle of the month to just before Christmas, during which period volatility drops from 2.4% above the December average (10th trading day) to 4.8% below the December average (17th trading day).
For the record, today is the 17th trading day of December, which makes the the historical low point in volatility for December.
I will not go so far as to say the that calendar suggests today is likely to be the last time the VIX dips under 42 for awhile, but those with an interest in historical context may wish to prepare for an increase in volatility, as the holiday ‘calendar reversion’ effect wears off.
[source: VIX and More]
Monday, December 22, 2008
Jeff Kearns and Michael Tsang of Bloomberg have an article out today (VIX Fails to Forecast S&P 500 Drop, Loses Followers) in which the authors contend that largely because the VIX failed to predict the October losses in the S&P 500 index (SPX), the VIX is no longer considered to be an accurate gauge of future market activity.
One of the central claims made by Kearns and Tsang regarding the lack of effectiveness of the VIX is stated as follows:
“On Sept. 11, less than a week before New York-based Lehman Brothers Holdings Inc. went bankrupt and four days after the government takeovers of Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac, the VIX closed at 24.39. That meant traders bet the S&P 500 wouldn’t fluctuate more than 24.39 percent on an annualized basis, or about 7 percent in the next 30 days, and implied a range for the index of 1,161.11 to 1,336.99.
One month later, on Oct. 10, the S&P 500 closed at 899.22, or a record 23 percent lower than what the VIX predicted.”
As fellow blogger Don Fishback was quick to point out, the VIX calculation actually estimates one standard deviation of annualized 30 day volatility expectations in SPX options. That standard deviation, of course, is meant to capture 68.3% of the Gaussian or normal distribution of prices. In fact, the distribution of VIX prices does not follow a normal distribution, but even if it did, the movements from September 11th to October 10th would not be that statistically improbable.
Some quick comments on the math involved here. Using a VIX of 24.39, the conversion of an annualized volatility of 24.39% to 30 day volatility yields a 30 day volatility of 7.04%. Two standard deviations translate into a 30 day volatility of +/- 14.08% and should cover about 95.5% of the normal distribution (I am assuming a normal distribution for the sake of mathematical simplicity). Three standard deviations increase the range of expected volatility to +/- 21.12% and should capture about 99.7% of the normal distribution. In fact, the 99.9% boundary for the normal distribution is 3.29 standard deviations and translates into expectations of an SPX move of 23.16%, about on par with what transpired. So, given that an event which falls outside of 99.9% probability distribution happens once every 1000 instances. Rare indeed, but not unfathomable.
Of course there are many ways in which to utilize the VIX to aid in market timing. Consider that the nature of the VIX calculation is such that the VIX acts as an unbounded oscillator whose values are derived from prices paid for options on the SPX. Like most oscillators, traders tend to use extreme values as opportunities to bet on a reversion to the mean.
A good deal of the difficulty in understanding the movements of the VIX is that some of the dominant patterns are different over the course of different time horizons. For instance, in the short-term, the VIX commonly spikes and mean reverts. Looking at the intermediate term, the VIX frequently establishes strong trends; and in the long term, the VIX has a tendency to move in cycles of 2-4 years. For the month of September and most of the month of October, the VIX was in an uncharacteristically strong sustained uptrend.
Part of the reason for the sharp move in the VIX during September and October is that it is highly dependent upon macroeconomic and fundamental events that help to shape investor perceptions of uncertainty, risk and fear. In the week leading up to the Lehman Brothers bankruptcy, for instance, very few investors believed that the government was prepared to let Lehman fail. Additionally, in retrospect is seems as if those who did believe failure was an option did not comprehend the nature of the systemic reverberations that a Lehman bankruptcy would trigger.
The bottom line is that during the second week in September, the VIX was pricing in a very low probability of a Lehman Brothers bankruptcy. Perhaps more important, investors were also assigning a significantly lower systemic threat potential as a result of the dominoes associated with a Lehman bankruptcy.
Ultimately, it took a full six weeks of a steadily trending VIX for the market to fully price in the global systemic risks associated with the sequence of events that began with the Lehman Brothers bankruptcy.
Consider that the prices and implied volatilities of SPX options have to account not just for the probabilities associated with various future scenarios, but also the magnitude of the impact of those scenarios on the stock market. For this reason, even while some of the probabilities may not have varied significantly from day to day during September and October, as the magnitude of the financial crisis was slowly revealed, the VIX continued to ratchet higher – and investors reacted to a rising VIX with increasing alarm.
Getting back to the question posed by Kearns and Tsang, yes the VIX underestimated future volatility back on September 11th. At that time, the prediction of a four year flood was consistent with mainstream thinking. Very few observers anticipated the SPX falling below 800 by Thanksgiving.
As the year winds down, I will have more about what we learned about volatility in 2008 and what some of the implications are for 2009 and beyond.
It is always nice to be acknowledged for the contributions you make, but it is particularly heartening when that recognition comes from a respected peer in the field. For that reason, I was pleased to see that Condor Options has included VIX and More in its list of the Top Finance Blogs of 2008.
The recognition is even more meaningful when I see the esteemed company this blog has on the list:
While these should all be familiar names to VIX and More readers, I do not believe I have yet featured the work of Ultimi Barbarorum on the blog. If so this omission is accidental, as Ultimi Barbarorum is a true thinking man’s blog in which the reader is treated to one side of the author’s ongoing dialogue with Baruch Spinoza. What could be a better way to pay tribute to the closet philosopher in all of us?
Saturday, December 20, 2008
Thanks to the Federal Reserve’s decision to drop their target Fed Funds rate to an all-time record of 0.00% to 0.25%, the subject of this week’s chart of the week is a no brainer.
The Fed has 55 years of Fed Funds rate data and I have chosen to highlight not the target rate announced by the FOMC, but the daily effective federal funds rate, which is a volume-weighted average of rates on trades arranged by major brokers.
Not surprisingly, Friday’s effective Fed Funds rate of 0.11% is a record low, but that record was actually established on December 10th and tied again on Friday.
For history buffs, the record high of 22.36% dates back to July 22, 1981. The average Fed Funds rate since 1954 is 5.62%.
[source: Federal Reserve Bank, VIX and More]
Friday, December 19, 2008
The range-bound action in equities over the last few weeks has brought us something we have not seen since October 3rd: a VIX below 42.
With the VIX futures for January and February still trading in the 47-48 range, the consensus opinion is that a 42 is not sustainable. In fact, supporting that opinion is the flurry of activity in the January 70 and 75 calls in the past few minutes, as speculators (and perhaps hedgers) jump at the pre-Christmas sale prices on VIX options.
The graphic below summarizes the action in the VIX January options, with almost all of the action in the January 75 calls coming as I type this.
Thursday, December 18, 2008
The VIX:VXV ratio has just triggered its first sell signal (for the SPX/SPY) since late August as a result of the VIX falling to the current level of 44.60.
Note that even though the holiday season typically has lower than normal volatility, I do not recalibrate the ratio or the signals to account for seasonal tendencies.
I have frequently posted about the issue of SPX and VIX correlations, but some of the comments following yesterday’s SPX Straddle Case Study Update indicate that it is time to dust off some statistics and address some of the issues that have been raised.
Reader Nirvanic lays out his thinking on the subject as follows:
“What I call a VIX/SPX non-confirmation, meaning that both the SPX and VIX were red. One of my main rules is that the VIX and the SPX cannot be the same color. When this happens there is something wrong. If the VIX and the SPX are green, then usually the SPX will go red and the same in reverse.
I have only seen a few days lately where there was a VIX/SPX non-confirmation. They are rare and so I don't have a lot of data on these. In the occurrences I have seen, the VIX has been the 'tell.' If this holds true, then tomorrow should be a green day because the VIX was right, not the SPX.”
Let me start out by saying that one of the my most read posts of 2007 was titled High Positive Correlation Between VIX and SPX Often Signals Market Weakness. The post is probably worth checking out just because it has one of my favorite photos on the blog, but of greater interest is likely one of my conclusions that “in looking at past periods of high positive correlations between the SPX and the VIX, it is notable that the SPX generally performs well below its historical mean for up to three months following the high positive correlation period.”
Nirvanic’s contention is more specific. His “non-confirmation” days are probably a lot more common that he realizes. Going back to 1990, when the VIX ends the day in the red, the SPX also closes down about 21% of the time. When the VIX is green, non-confirmation is even higher, at about 25%.
In terms of performance, it is easy to think of the possibilities as a 2x2 matrix, with the VIX either up or down on a daily basis and the SPX negatively correlated or positively correlated with the VIX.
Let me summarize the considerable research I have done on the subject by saying that if there is one pattern among the four that is most predictive of above average future returns, it is the one in which the SPX finishes the day in the red while the VIX finishes in the green. Conversely, as Nirvanic suggests, the pattern associated with below average future returns is the one in which the SPX is up and the VIX is up.
Each of the two remaining patterns demonstrates very little variation from typical market performance; in fact the SPX down, VIX down pattern slightly outperforms the SPX up, VIX down pattern.
Note that all data cited above reflect single day changes in the SPX and VIX. At some point in the future I will share some of my research into longer-term changes in the SPX and VIX patterns, as well as their trading implications.
Wednesday, December 17, 2008
I mention very few possible trades on the blog and when I do so it is always for illustrative purposes only. As a consequence, I rarely feel an obligation to follow up on a previous post that identified a possible trade.
Today, however, seems like an opportunity that is too good to overlook because the timing and the math just happened to work out so nicely.
Exactly one week ago, in Is the SPX Going to Stick Close to 900?, I outlined my opinion that I thought there was a strong chance the SPX “would settle in a trading range of 820-980.” I also mentioned the “possibility that the SPX might start to feel some gravitational pull around the 900 mark and start trading in an even narrower range, with the 900 area becoming a No Man’s Land of sorts.”
For those who might have similar thoughts about the market and were looking to harvest some volatility as income, I suggested a menu of strategies that included straddles, strangles, condors, and butterflies.
I chose to illustrate one possible range bound trade with a short straddle using the S&P 500 index (SPX) as the underlying. With the SPX trading at just a shade over 900 at the time, the puts and calls could each be sold for 30.00 per contract. Fast forward one week and the SPX is still hovering around 900. After one week of time decay and a VIX that has fallen approximately 10% during that period, both the puts and calls have had their prices cut in half, from 30.00 to 15.00.
As expiration approaches, options trades move from the realm of investment to crap shot, but it is interesting to see a real life case study in time decay in which all the numbers behave as they normally do only in a textbook.
Tuesday, December 16, 2008
I have recently received several requests to update research I posted in the first month of the blog (January 2007) under the title of VIX Price Movement Around FOMC Meetings.
The general pattern identified almost two years ago is still intact. In the chart below, I have aggregated the data for 19 years of VIX history covering a period spanning ten days before to ten days after some 150+ FOMC meetings. With the closing VIX price on the Fed days indicated by a black dot, it is easy to identify a pattern of volatility increasing in the week prior to the announcement, then dropping dramatically for three days following the announcement, and slowly building back to pre announcement levels thereafter.
Not surprisingly, one of the most predictable aspects of the VIX is that it has a tendency to increase dramatically on the day before the announcement as anxiety builds about possible changes in Fed policy, then drop by about 2.3% on the day of the announcement as the markets discover that the worst fears were not realized and/or the Fed’s actions and statements had been largely discounted in advance.
For a more detailed interpretation, check out my commentary in the January 2007 post.
[source: VIX and More]
Monday, December 15, 2008
The VIX term structure is a series of calculations of implied volatility on SPX options stretching out months and years into the future. The terms structure highlights how future expectations of volatility in the SPX as derived from IV data reflect changing expectations about how volatility will evolve over time.
The concept is best illustrated with an example.
In the chart below, I have plotted the VIX term structure from November 20, 2008 and again at the close on last Friday, December 12. November 20th marks the high water mark for the term structure, when implied volatility for the SPX options closed at their highest levels of the year. The current data shows how implied volatility has fallen dramatically in the front months and incrementally in the second half of 2009 and beyond.
At this stage, market participants are anticipating market volatility will peak in February at about 57, then gradually decline to a level in the 43-44 range by the end of 2010. In contrast, back in November, traders were of the opinion that SPX implied volatility (the VIX) was extremely extended and would mean-revert rapidly, as has been the case.
One way to think about the difference between the November 20th term structure and the December 12th term structure is that the change represents the amount of volatility, risk or uncertainty that has been removed from the S&P 500 index during the course of a little over three weeks.
Sunday, December 14, 2008
With the excellent set of links churned out almost daily by Abnormal Returns and less frequently by The Kirk Report, I am less inclined to toss my link hat into the ring, but readers always ask for more…so I have assembled a list of ideas from around the blogosphere that I have been pondering the past few days.
- Economic Winter Reflected in Shipping, Capex, Jobs, Treasury Yields (Mike Shedlock)
- Our Asset-Dependent Economy (Tim Iacono, The Mess that Greenspan Made)
- The Consumer Trade-Down Costco Style (Jeff Mathews)
- Capitalism II: Brave New World (Jesse’s Café Américain)
- The “D” Keeps Rising (James Picerno, The Capital Spectator)
- The Fed Not as Leveraged as Shown (Toro’s Running of the Bulls)
- Producer Price Inflation Not Dead (Scott Grannis)
- Gold at Significant Turning Point (Corey Rosenbloom, Afraid to Trade)
- Cygnophobia and Robustness (Condor Options)
- FTDs [Follow Through Days] After the Crash of 1929 (Rob Hanna, Quantifiable Edges)
- Breadth Indicators on Their Fifth Attempt at a Bottom (Declan Fallond)
- Trading with RSI (2) (Michael Stokes, MarketSci)
- More Fun with Levered ETFs (Paul Kedrosky, Infectious Greed)
- Are ETFs to Blame for Market Volatility? (Kevin Grewal, ETF Trends)
- Stock Panic Volatility (Adam Hamilton, Zeal)
- The Volatility Bubble – Average Daily Change Now Above 4%! (Bespoke Investment Group)
…and just for fun…
Saturday, December 13, 2008
As the chart below shows, the dollar has been negatively correlated to stocks for the past five months or so. Historically, a falling dollar has generally not been positive for stocks. It will, however, provide some support for exporters and enhance demand for commodities that are quoted in dollars across the globe.
For the most part, the strength of the dollar usually reflects traders’ opinions about the strength of the U.S. economy relative to economies associated with the other major currencies. When the dollar was rising, therefore, it was not necessarily a vote of confidence in the U.S. economy as much as it reflected a concern that other nations may be in an even more difficult situation. Now with the mushrooming U.S. debt on top of an already severe economic crisis, the prospects for the U.S. economy relative to that of some of other global economies is being reevaluated from one of the strongest to perhaps only slightly better than average.
The dollar appreciated approximately 23% from July to November. This week the dollar moved below its 50 day moving average for the first time since the July bullish move again. Trend indicators such as the Aroon are starting to reflect a reversal in trend; expect trend-following systems to be short the dollar as the new trend becomes more pronounced.
Do not be surprised to see half of the 23% gain disappear in the next few months.
[source: StockCharts, VIX and More]
Friday, December 12, 2008
Generally the thought of buying some options on the cheap is not consistent with an implied volatility (IV) of 232.
Today, I have a counterexample to consider.
Take the case of FAS, one of the new Direxion triple leverage ETFs. FAS is intended to track 300% of the price performance of the Russell 1000 Financial Services Index. In the recent market environment this has proven to be a daunting task, resulting in FAS racking up a 30 day historical volatility number of 332 – a full 100 points higher than the current implied volatility.
In practical terms, an IV of 232 translates into an anticipated average change of 14.6% per day. For comparison purposes, an IV of 332 translates into an average daily move of 21%. So far the mean one day change in closing prices for FAS has been 17.4%. Looking at recent history, an implied volatility of 232 may turn out to be a bargain and options in FAS may not be as expensive as they look…
For all the talk about the auto bailout fiasco, a little more than two hours into the final trading session of the week finds the markets relatively unchanged since last Friday. As I type this the SPX is hovering around the 862 mark, down about 1.5% for the week.
Interestingly enough, the VIX has also fallen this week and is currently down about 4.4% from last week’s close. In fact, the VIX is setting up for the sixth close in a row of under 60 – the first time this has happened in over two months.
Shorts had an hour or two of fun yesterday, but the buy on the dip crowd appears to be back out in full force today, with technology, small caps, real estate and homebuilders catching a bid.
As long as the VIX keeps dropping, it is reasonable to assume that buyers will continue to step in aggressively to support the market when it pulls back.
At the very least, expect bears to start to lose their nerve if the current pattern continues.
Posted by Bill Luby at 9:01 AM
Thursday, December 11, 2008
For the last three weeks, I have been impressed by the confidence and resolve shown by the bulls as they have consistently used pullbacks to flood the market with new long positions. Perhaps algorithms have no fear…
More recently, however, as the bull leg has stalled around the SPX 900 mark, I have found myself thinking about the lack of ‘proper’ leadership. Yesterday and today, the rallies have been led by commodities, with gold and energy equities the top performers.
At the same time, the three sectors I think are most critical to the recovery, my so-called ‘indicator species’ sectors (financials, homebuilders and consumer discretionary stocks), have been unable to get out of the red today.
I am not sure where the leadership will come from that will eventually push the SPX back over 1000. Today large cap technology names First Solar (FSLR), Apple (AAPL), Dell (DELL), Research in Motion (RIMM), eBay (EBAY) and Intel (INTC) are all strong performers. Frankly, I would expect technology to play a strong role in the next big leg up, but leadership may come from a number of other sectors.
There are few guarantees in the stock market, but I can guarantee that gold and energy are not going to pull the SPX up over the 1000 mark and leave financials (XLF), homebuilders (XHB), and consumer discretionary stocks (XLY) behind.
Wednesday, December 10, 2008
For what it's worth, I'm short right now, as among other factors I am suspicious of a DJIA that is up 187 points largely behind strength in gold and the energy sectors.
Meanwhile, financials are in the red.
Will financials pull the broader market back down? Will commodities lift the market higher?
The more I think about it, the more I think we are moving closer to a deadlock and the more I like that SPX straddle trade...
It is generally my intent at VIX and More not to recommend specific trades, but to highlight different ways to think about volatility. With that in mind, consider that during the past three days, the S&P 500 index (SPX) has straddled the 900 level in the closest thing to a sideways trading range since August.
Since the November 21st low, I have been anticipating that the SPX would settle in a trading range of 820-980. So far the SPX has not traded north of 920, but I would not be surprised to see this happen.
What is even more interesting is the possibility that the SPX might start to feel some gravitational pull around the 900 mark and start trading in an even narrower range, with the 900 area becoming a No Man’s Land of sorts.
If the No Man’s Land scenario plays out even for just the next seven days, it is possible to lock in some nice gains with a straddle (or strangle, condor, butterfly, etc.) on the SPX, the SPY, or one of the leveraged variants.
As the graphic below from optionsXpress shows, the bet is essentially that the SPX will remain in a range of 60 points in either direction (a little less than 7%) in a little less than 7 trading days. The bottom line: seven percent in seven days. Volatility tends to decrease during the holidays, which would be a positive factor for those who choose to sell volatility.
If you are thinking about how one of the new 3x ETFs might play out in a similar trade, BGU is currently trading near 36 as I type this and a short straddle would be profitable in a range of about 28 to 42 – essentially a range of 20% in either direction.
Tuesday, December 9, 2008
I have commented on resurgent Chinese stocks several times in the past few weeks, most recently in China About to Break Out? Now that Chinese stocks (FXI, black line) appear to be on the rebound, an important question is whether this is an isolated phenomenon or one that will also affect other emerging markets economies.
As the chart below shows, the rally in Chinese stocks has significantly outdistanced the recent bounce in emerging market stocks (EEM, orange line). It is the other three members of the BRIC group, however, that are lagging China and the broad emerging markets group the most. Not surprisingly, commodity-rich Russia (RSX, blue line) is the biggest laggard among the BRIC countries, while India (EPI) and Brazil (EWZ) are trailing the broader emerging markets index, but performing better than Russia.
The question of whether growing domestic demand and a massive government stimulus package will result in a China-specific rebound or help pull other global economies along for the ride is not likely to be answered soon. In the meantime, China looks strong on a relative basis and other emerging economies should be watched closely for clues about the geographical breadth of the rally.
Monday, December 8, 2008
Three weeks ago last Friday I thought I may be sticking my head out a little too far in Prediction: Direxion Triple ETFs Will Revolutionize Day Trading. Well, here we are barely three weeks later and these triple ETFs are racking up more volume in the first half hour of today’s session than they did in an entire trading day when I made my original prediction. (see graphic below)
In short, the revolution has already arrived.
Sure, there have been some issues with tracking error as Adam at Daily Options pointed out in Triple the Fun. On an intra-day basis, however, these ETFs seem to track and trend relatively accurately. And if you get the direction right, are you really going to be upset that you were right a factor of say only 2.7 times the underlying instead of an advertised multiplier of 3.0? Either way, it was still probably a wise allocation of capital.
The next frontier may turn out to be options strategies associated with these 3x and -3x ETFs. All eight of these ETFs are optionable and options activity seems to be picking up rapidly, particularly in BGU, the large cap 3x bull ETF, which currently sports an implied volatility of about 150 and a historical volatility in excess of 200.
Sunday, December 7, 2008
The following is adapted from a subscriber newsletter segment that appeared in the November 26th newsletter.
I have never seen any research on the subject of VIX double tops, but given the recent double top formation in the VIX, I thought this might be a good time to share some of my thinking on the subject. First, the chart at the right shows the recent VIX levels from mid-August to the present. The first spike in the double top comes on October 24th and the most recent spike comes on November 19th.
Double tops are fairly common in the 19 year history of VIX data and frequently coincide with extreme readings in the VIX. By contrast, VIX triple tops are relatively rare; and while single VIX spikes are common in more mundane market conditions, they are less likely to be found at VIX extremes than double tops.
In fact, prior to this year, the three crises with the most extreme VIX readings were the 1997 Asian Financial Crisis, the 1998 Long-Term Capital Management Crisis, and the 2002 bottom of the technology bust that accompanied the WorldCom bankruptcy filing. In the graphs below, I have recorded the history of these VIX spikes. You can clearly see a double top pattern in the VIX in all three instances. Interestingly in each instance, the spikes were separated by approximately 2-3 weeks and signaled major turning points in the markets.
Recent events have shown that extrapolating from past chart patterns to the current market is fraught with danger, but I would argue that the presence of a VIX double top reinforces the case that the recent stock market bottom will prove to be an important market inflection point.
[source: Yahoo, VIX and More]
Saturday, December 6, 2008
The word of the year may be bailout, but when it comes to the stock market, the operative word for this week is resiliency.
On Tuesday, Wednesday and again on Friday, stocks shrugged off bad news and sharp declines to post solid gains. Yesterday’s feat was perhaps the most impressive of all, after November nonfarm payrolls shocked even the most pessimistic estimates by falling 533,000. Following the release of the employment data, the Dow Jones Industrial Average was down 292 points (3.5%), before putting on a furious 638 point (7.9%) rally and eventually ending the day with a 259 point gain, up 3.1% from Thursday’s close.
This week's chart of the week captures the payroll predictions of the 73 economists surveyed by Bloomberg prior to the release of the employment report. The actual nonfarm payroll number of -533,000 is more than four standard deviations away from the mean prediction and is indicated by the dotted black line to the right. Given that this result triggered a 3.1% rally, one wonders what might have happened to stocks if the employment data had been near the median prediction of a 333,000 loss or perhaps even the more optimistic projections of a loss in the vicinity of 220,000.
Going forward, economic data releases are on the light side until the end of next week, but watching how stocks react to the news flow next week may go a long way toward determining the character of the recent buying activity.
Friday, December 5, 2008
For most of 2008, the three sectors I have been watching most closely to gauge the health of the economy are financials (XLF), homebuilders (XHB), and consumer discretionary stocks (XLY). I have even referred to these sectors as my ‘indicator species’ sectors, as I am of the opinion that unless all three of these sectors are healthy, the health of the broader economy cannot be assured.
In the past two weeks, relative strength all three of the above sectors has helped the broader market indices put in what is no less than a provisional bottom. Financials have been the most consistently strong sector, with the XLF financial ETF now 35% above its November 21st low.
In the chart below, I have attempted to break out the relative performance of various financial sectors over the past three months, using four ETF from the financial sector specialist Keefe, Bruyette & Woods (KBW). The chart dates back to September 5th, ten days before the Lehman Brothers bankruptcy. The baseline ETF (black line) is KBE, which tracks the KBW bank index. The top performer among the other three ETFs is KRE, the KBW regional banking index. The two laggards are KIE (KBW insurance index) and bottom-dweller KCE (KBW capital markets index.)
In relative terms, insurance and capital markets seem to have enjoyed the more impressive bounce off of the November low. Regional banks, which actually showed small gains in September, have been acting more sluggish as of late. More dominoes are certain to topple as the ripple of the financial crisis continues to broaden its reach, but the recent relative strength in insurers and investment banks bodes well for the financial sector, which just might provide leadership when the next bull leg commences.
Thursday, December 4, 2008
It was only ten days ago that I thought I would be provocative with an early call on China in Time to Be Long China? Since that time, what looked like a possible cessation in downside momentum has turned decidedly more bullish, with the FXI rising an additional 10%.
The chart below shows FXI, the iShares FTSE/Xinhua China 25 Index ETF, closing above its 50 day simple moving average (SMA) for the first time in 4 ½ months yesterday. It has been 27 trading days since the FXI put in a bottom. Since that time, the Chinese ETF has rallied more than 40% off of that bottom.
If FXI can close above its 50 day moving average again today, it will mark the first time in over six months that FXI has closed above that important technical level on consecutive days. Ten minutes into today’s session, FXI is trading at 26.70, down 0.55. With the 50 day SMA at 26.94, any close at 27.00 or above should leave a fairly bullish signal on the chart and support the case for increasing upside momentum.
Wednesday, December 3, 2008
I’m glad to see that yesterday’s Arms Index Extremely Extended post received so much attention.
One of the concerns raised by a reader was that my chart of the Arms Index (TRIN) only looked back to four years of history, so that the historical context prior to the current bear market consists entirely of bull market readings. For this reason, today’s chart goes all the way back to the beginning of TRIN data available at StockCharts.com.
In the chart below, the 17 years of TRIN data results in such compressed and difficult to read 10 day EMA cycles that I have lengthened the exponential moving average period from yesterday’s 10 days to a 30 day EMA. Fortunately, because it is an EMA instead of an SMA, the peaks in the TRIN cycles are almost identical whether the EMA period is 10, 30 or 50 days.
I have also removed the red and green horizontal lines from this long-term chart to reflect the fact that the TRIN had a lower mean prior to 2000, trended higher during the bear market from 2000-2003, and seems to have found a new mean value from 2004 through 2008. For this reason, considered over the course of multi-year time frames, the TRIN is best thought of in relative terms rather than absolute terms.
As I noted with yesterday’s chart, spikes in the TRIN have “historically provided excellent buying opportunities.” Low TRIN readings may also have some value from a market timing perspective, but these signals are generally not as robust as high TRIN readings. Finally, the TRIN is far from perfect in predicting market inflection points, but it does have a track record that is accurate enough to bear watching. As I noted yesterday, the TRIN is best suited for short to intermediate-term setups.
Tuesday, December 2, 2008
The Arms Index or TRIN is an indicator that I watch closely for short to intermediate-term setups. The indicator which combines ratios of advancing issues to declining issues and advancing volume to declining volume is a reasonably reliable contrary signal.
Since mid-October the Arms Index has been generating a number of historically high signals. In the chart below, I used a 10 day exponential moving average as a smoothing factor. Note that the TRIN’s 10 day EMA appears to have climaxed yesterday in the manner that has historically provided excellent buying opportunities. To my ears, yesterday’s climax in the TRIN is suggesting that the November 21st bottom is likely to hold. Shorts beware…
Monday, December 1, 2008
I am sure many out there are wondering just how bad an Institute for Supply Management (ISM) index of 36.2 is in the historical context and just what it may mean for the stock market.
Rather than a bunch of statistics, I thought the chart below might help. It identifies the six previous instances since 1950 in which the ISM index dipped as low as the current level.
Not surprisingly, historical precedent recalls a number of difficult economic periods. What I find particularly interesting is that, consistent with the belief that stocks are a leading indicator, when the ISM bottomed, this was often after stocks had made a substantial move off of their eventual bottom.
A reader asked about the historical significance of the VIX dropping 30.9% in the last five trading sessions. This has only happened six times since the beginning of the VIX data history in 1990. If we lower the bar to a 30% drop in five days, we pick up a total 8 instances; and if we move the threshold down to a 25% drop in five days, the number increases to 32 occasions, including quite a few data points that fall on consecutive days.
If you do this type of analysis often enough, you begin to be able to pick the years that will be most prominent on the screen: 1991, 1994, 1997, 1998, 2002, and 2007. Now 2008 is starting to make its impression in the historical database as well.
The question most people are interest in, however, is not so much the year of the previous instances as the subsequent performance of the stock market in the days and weeks following these 30% drops. The data show almost identical performance patterns for 25% and 30% five day drops in the VIX. Essentially, there is a very strong probability that during the next five days the SPX will be down at least 1% or more. Following the classic mean reversion tendency, in looking out 10 trading days or more, the underperformance gap begins to diminish significantly, so any shorts opened today should have an anticipated lifespan of 10 days or less.
Sunday, November 30, 2008
Anyone who has yet to experiment with Wordle is missing out. First brought to my attention by Barry Ritholtz at The Big Picture, Wordle is a site that lets users turn text into a word cloud, with a wide array of creative options.
Wordle can be used purely for fun, for analysis, or for any number of purposes. It might also have some value as an archival tool too.
Without further ado, here is a Wordle word cloud for all of the VIX and More posts from November 2008:
[source: Wordle, VIX and More]
Saturday, November 29, 2008
The chart of the week looks like it will now be a regular feature in this space. This week’s theme, once again, has a bond focus and extends the flight to safety theme from last week. The graphic below captures the full 46 year history of the yield on the 10-Year U.S. Treasury Note. While difficult to discern from the graph, this is the first week the yield on that bond has ever closed below 3.0%. The reason for the low yield is the overwhelming demand cause by investors who are embracing a flight to safety approach to investing and see U.S. government debt as a safe haven for their assets.
The low yields on U.S. government debt have several interesting implications. One implication is that a falling VIX does not reflect the action in the government bond markets. Another implication is that rising yields will indicate when money is starting to flow out of safe haven investments toward higher risk investments such as stocks. Finally, when the bulk of those currently holding government debt decide that it is appropriate to redeploy these assets into stocks, the pent-up demand for equities will be a formidable factor to reckon with.
Friday, November 28, 2008
I am moving closer and closer to a regular feature along the lines of “The Week in Volatility.” I’m not quite there yet, so today I am going to turn the keyboard over to others around the blogosphere who have posted some interesting articles of note about volatility from the past week:
- Berkshire Hathaway’s Peculiar Volatility Numbers, Berkshire’s CDS and Counterparty Hedging, and Berkshire’s Puts: Not Such a Great Idea (Felix Salmon)
- Valuing Large Options in the Absence of Collateralisation (Financial Crookery)
- The Most Volatile Market Ever (Bespoke Investment Group)
- An Alternate (Simple) Explanation for Market Volatility (Humble Student of the Markets)
- A Turn in Historical Volatility (Condor Options)
- BEP Avenue Freezout (Daily Options Report)
- Two Ways to Interpret the VIX (Alex Trias)
Thursday, November 27, 2008
When you are done with all the turkey, stuffing and pumpkin pie, consider some exercise.
The chart below, courtesy of the Mayo Clinic, spells out how much exercise it will take to burn off the gastronomic excesses of the day:
[source: Mayo Clinic]
Posted by Bill Luby at 1:38 PM
Wednesday, November 26, 2008
Just 12 days ago I came out with what I thought was a bold statement in Prediction: Direxion Triple ETFs Will Revolutionize Day Trading. I was going to do a follow-up to show how volume has skyrocketed in these ETFs, but Bespoke beat me to it in today’s 3x ETFs on Fire. Bespoke includes some excellent graphics that capture the extreme volatility in these ETFs as well as the snowballing volume trend.
Personally, I continue to transition more and more of my trading from stocks to ETFs. I think the ETF trend is here to stay.
I have been receiving quite a few questions about gold and gold volatility lately, so with gold receiving a lot of attention in the press, I thought this would be a good time to check in on the commodity and on the CBOE’s gold volatility index (GVZ), which was launched back in August.
Gold is something every investor should be watching these days as it reflects the ebb and flow of opinions about the risk of deflation in the short run and inflation over the longer run.
In the chart below, I have captured the price action in the commodity as tracked by GLD, the popular gold bullion ETF. I have also included the GVZ (aka “Gold VIX”) to gauge some of the recent volatility in gold trading. Gold volatility peaked back on October 10th and has been in a gradual downtrend for the past six weeks. The chart reflects that spikes in gold volatility have generally coincided with spikes in the price of the commodity.
The broader issue of correlations between gold prices and volatility is much more complicated and subject to cyclical swings. In the chart I have highlighted two periods in which gold and gold volatility have shown a persistent negative correlation, first in August and later in mid-October. These two instances were both bearish for gold prices, yet when the correlation switched back to a positive one, gold prices began to move up in both instances.
It is still too early to draw any definitive conclusions between gold prices and gold volatility, but I will return to this subject periodically as my thinking evolves on the subject.
[source: VIX and More]
Tuesday, November 25, 2008
Kudos to Michelle Leder at footnoted.org for some excellent spadework involving yesterday’s proxy filing for plastics company A. Schulman (SHLM). In “Gone Fishing – Seriously…” Leder flagged the section I have highlighted below in bold italics, but I thought it might be even more interesting to put the outlandish excerpt in the context of the broader scope of original document. The quotation is lifted from page 26 from a section with the title “Perquisites and Personal Benefits.”
“In April of 2008, the Compensation Committee eliminated most perquisites and personal benefits that previously had been extended to our North American Named Executive Officers, such as providing automobiles and related costs, and increased their base salaries as compensation for foregone benefits ($32,000 for Mr. Gingo and $8,000 for Mr. DeSantis). No changes were made to the perquisites provided to our European Named Executive Officers, as such perquisites are more in line with European compensation practices. We continue to maintain a founders’ membership at Firestone Country Club, which membership entitles us to designate five persons as members, one of whom is Mr. Gingo. The Compensation Committee believes that this membership is a cost-effective method of providing business related entertainment to our customers and business partners. The Compensation Committee also determined to continue reimbursing a Named Executive Officer for temporary housing expenses because the continued uncertainty relating to activist shareholders’ demands makes it difficult to require the Named Executive Officer to permanently relocate to Northeastern Ohio.
During fiscal 2008, the Compensation Committee determined that maintaining a lease on a private airplane was no longer a cost-effective method for providing business-related transportation to our Named Executive Officers and Directors. The airplane was used only for business-related travel, and personal use was not permitted. With the termination of the lease on the airplane, it also became increasingly difficult and cost prohibitive to access our Canadian fish camp. Consequently, the fish camp, which was only used for business entertainment purposes, was offered for sale during 2008. The only offer to purchase the fish camp came from Terry L. Haines, our former Chief Executive Officer and President. Ultimately we negotiated with Mr. Haines to sell the fish camp for a purchase price of $55,000 and the transaction closed during fiscal year 2009.
For fiscal 2009, the only other personal benefit that will be provided to all executive officers is a mandatory physical every two years to help ensure the health and welfare of our key personnel.”
For those who are strict adherents to the cockroach theory of malfeasance, A. Schulman’s stock made a new 52 week low on Friday and closed today 15.8% above that low. Speculators are betting heavily against the company, with the put to call ratio recently spiking dramatically to a two year high.
A. Schulman’s official motto is “Compounding the Imagination.” Perhaps they meant confounding…
Yesterday’s announcement of a $306 billion toxic asset safety net for Citigroup (C) was warmly received in the equity markets and has the potential for helping triggering the first three day rally in stocks since what seems like the Eisenhower administration.
Perhaps even better than the news in the equity markets is the impact that the Citigroup rescue has had in the pricing of credit default swaps (CDS) of financial institutions. Yesterday, for instance, the cost of credit default insurance at Citigroup was essentially cut in half, which is not surprising, given the nature of the agreement. The domino effect at other troubled financial institutions was notable, with CDS prices improving as follows:
- Goldman Sachs (GS): 68 basis points (18%)
- Berkshire Hathaway (BRK-A): 86 basis points (19%)
- Morgan Stanley (MS): 74 basis points (14%)
- Hartford Insurance Group (HIG): 214 basis points (10%)
For those not versed in the details of credit default swap pricing, each basis point translates into $1000 per year for 5 years to insure $10 million worth of debt, so a 5 year $10 million CDS for Goldman Sachs became $68,000 cheaper in the wake of the Citigroup deal.
The market likes the deal. I think the approach makes sense. Better yet, the Citigroup rescue may provide a workable template for how to best deal with troubled financial institutions in a manner than the government, firm, and market all find acceptable.
Monday, November 24, 2008
Back on October 10, 2007, in a post with the title When to Short China? I predicted:
Eventually, there will come a time when you will look back and say to yourself, “Why wasn’t I short China? It was such a no-brainer…”
In the 13 ½ months since that post, the iShares FTSE/Xinhua China 25 Index (FXI) has fallen from a split-adjusted 63 to 24 and change, a loss of about 62%.
Now predicting tops and bottoms is always a dangerous parlor game, but investors should always be wary of potentially important tops and bottoms.
Returning to China, notE that in the chart below, last week’s low in the FXI was about 5% higher than the October low, with Friday’s rebound accompanied by record volume. I would not likely confirm a rally in FXI until it closed over 28 or so, but the signs of a bottom look more promising in the FXI than they do in many corners of the U.S. equity markets.
There is considerable disagreement about how much of the $586 billion Chinese stimulus package accounts for new spending and how much references projects that had already been committed to, but were relabeled to fit under the stimulus umbrella. There is also a broad range of opinions around the amount the Chinese economy has slowed, with current estimates pointing to economic growth of 7% at the high end to perhaps the possibility that the Chinese economy might be shrinking. As additional light is shed on these issues, expect the FXI to lurch dramatically up and down. Do not be surprised, however, if the October 27th low of 19.35 turns out to be the bottom.
Sunday, November 23, 2008
I have been mulling over some ideas for new features on the blog (feel free to suggest some possibilities in the comments below) and one of these is a chart of the week that highlights what I think is a particularly salient development from the past week. This week, of course, there are many possibilities to draw upon, given some of the historic market activity. Friday’s Citigroup implied volatility chart is one such example.
Some readers may recall that following the Lehman Brothers bankruptcy in mid-September I highlighted this same ratio in a chart going all the way back to 1990 in Volatility Catastrophe Graphic. At that time, the VIX:IRX ratio had just exceeded 100, shattering the all-time high set in March when the ratio jumped to 5.3 on the heels of the Bear Stearns failure. This week the ratio took another quantum leap, surpassing 1600 at one point and closing at 726.
When it comes to measuring fear, VIX is only part of the story. The VIX:IRX ratio paints a much broader – and darker – picture of fear and the flight to safety.
Friday, November 21, 2008
The International Securities Exchange (ISE), which publishes a superb implied volatility chart that I have featured on VIX and More on a number of occasions, has recently launched an enhanced version of their IV chart. The new version of this chart, which I have appended below, adds an “ISEE value” to the list of data. I have discussed the ISEE call to put ratio frequently in this space in the past. In this incarnation it is simply a ratio of call volume to put volume for the specified security.
I chose Citigroup (C) as my example security because all eyes should be on this bank, which is now trading at a 14 year low after hitting 3.57 earlier this morning. If Citigroup crumbles, it will dwarf the chaos created by AIG and Lehman Brothers.
Finally, for more information on the company that is the source of the volatility charts used by the ISE, check out Livevol.
[source: International Securities Exchange]
Yesterday the VIX closed above the 30 day historical volatility of the SPX for only the sixth time since October 10th. Of interest to some, the SPX has performed extremely well in subsequent trading days on four of those five previous days, logging gains of 11.6%, 10.8%, 4.78%, and 4.3%. The sole loss was a day in which the SPX fell 3.2%. Extending this analysis farther back in time reveals a less impressive, but still positive recent pattern.
Thursday, November 20, 2008
It is unusual to see the markets bounce off of a bottom and the VIX still continue to climb, but that is exactly what has happened over the past few minutes, with the VIX up to 80.35. This divergence usually resolves in a bearish fashion.
Interestingly, the VIX December 100 calls that I referenced in the previous post have pulled back to a bid/ask of 0.75 - 1.00, with 774 contracts now traded.
In early October I set forth some of my ideas around how to think about volatility in A Conceptual Framework for Volatility Events. Today I want to briefly touch upon a topic that is tangential to that conceptual framework and closely linked to the VIX:VXV ratio that I talk about on a regular basis.
My thesis is simply this: the VIX looks out 30 days into the future and captures “event volatility” – or the volatility that is associated with events that are expected to occur in the next 30 days. These include Fed meetings, important economic data releases (employment report, consumer prices, retail sales, durable goods orders, GDP, etc.), earnings from bellwether stocks, even hurricanes, geopolitical crises and other events which can expect to cast a shadow over the course of the next 30 days.
The other half of the thesis is that the VXV (essentially a 93 day version of the VIX) always incorporates a full earnings cycle and a full economic data release cycle – so these events have very little impact on the VXV. As a result, the volatility that is relevant to the VXV is structural or systemic.
If this thesis is correct, it has some interesting implications for interpreting the VIX:VXV ratio and the VXV in isolation. For instance, yesterday’s new highs in the VXV, which occurred without the VIX even coming close to a new record, suggests that traders are currently pricing in record amounts of structural or systemic risk. In the long run, this "structural volatility" is a lot more dangerous than the event risk associated with the VIX.
Wednesday, November 19, 2008
There is still an hour and a half left in the trading day, but it is beginning to look like the VIX will close over 70 for the first time this month and record its third highest close ever.
At 2:37 p.m. ET the VIX is at 73.62, well off of the record 80.06 close from October 27 and the second place 79.13 close of October 24 from the preceding Friday.
A lot can -- and usually does -- happen in the last half hour, but clearly the markets have a long way to go before fear and anxiety start to recede.
[Edit: the final number on the VIX is 74.26, though the index did touch 75.00 for a moment]
Posted by Bill Luby at 11:36 AM
Lately there have been quite a few days when it looks as if the market is wearing ‘concrete shoes’ and will never be able to keep its head above water. Time and time again the financials look like those concrete shoes: financials plunge; the market follows.
In fact the performance of financials relative to the broader market has been weakening steadily since early October 2006, when the ratio of financials (XLF) to the S&P 500 index (SPX) peaked. The chart below tracks this ratio since the beginning of 2006 and shows how financials have pulled the broader market down. Additionally, the chart reveals that almost every temporary improvement in the ratio has been an excellent shorting opportunity.
The chart also demonstrates that temporary bottoms in the ratio have presented some tradeable though short-loved opportunities on the long side. This morning the XLF and the XLF:SPX ratio are once again making new lows. Eventually the ratio will find a bottom. If the patterns in this chart hold true to form, the bottom in the ratio will precede a bottom in the SPX.
Tuesday, November 18, 2008
VIX options expire tomorrow morning in a VIX special opening quotation (SOQ) and with only one hour of trading left today VIX calls that are still almost two dollars out of the money (November 75 calls) just traded at 1.20, suggesting that traders see a significant probability that market conditions could deteriorate over the course of the last hour or open down sharply tomorrow on additional bad news.
The graphic below, courtesy of optionsXpress, show the prices up through the 85 strike for the VIX November options, with the snapshot taken at 2:52 p.m. ET while the VIX was at 73.13:
Something interesting happened yesterday that has happened very rarely over the past two months or so: 50 day historical volatility (HV) in the S&P 500 index dropped. While that fact in itself might not be worth of a headline next to the latest installment of ‘Adventures in TARPland,’ there is a strong possibility that historical volatility in the SPX has just peaked.
Actually the 10 day version of historical volatility for the SPX peaked back on October 22nd, followed by the 20 and 30 day HV topping out on November 5th and November 7th. It is too early to say definitively that 50 day historical volatility will not exceed Friday’s high, but the odds are in favor of it, as it is only a couple more days before the Lehman-powered selloff of September 15th scrolls off of the 50 day lookback window.
Now I’m sure this bit of volatility trivia is not likely to excite readers, so I have included a chart below which shows the last three times 50 day historical volatility in the SPX has peaked at a level of 30 or higher. While all three previous instances (marked by the blue arrows) have turned out to be excellent buying opportunities, finding historical parallels to help interpret the current market situation has lately been an approach fraught with danger.
A better way to think about historical volatility rolling over is that like the VIX, historical volatility is a barometer of some of the uncertainty and emotional components of the markets. As these readings begin to pull back from recent highs, investors of all persuasions are more likely to enter the markets.
Monday, November 17, 2008
The events of 2008 have completely reshaped the landscape of the U.S. commercial banking industry. At this point it looks as if four major banks will emerge as the dominant players: two relatively strong ones; and two that face a more challenging competitive environment. Here the charts identify the players nicely. From the peak of October 2007, Wells Fargo (WFC) and JPMorgan Chase (JPM) have each fallen about 20%, less than one half of the drop in the financial sector ETF, XLF. At the other end of the spectrum are Bank of America (BAC) and Citigroup (C), each of which has seen their stock drop at least 65% during this period. See the top chart for details. Refocus to the period since the failure of Bear Stearns (bottom chart) and the pattern is even more dramatic, with WFC and JPM each down a little more than 5% while BAC and C are down over 35%.
XLF made a new low of 11.70 on Thursday and is trading at about 12.00 as I type this. If XLF and the large commercial banks are not able to scrape out a bottom, then this market will not be able to sustain any rally. Better yet, add XHB (homebuilders) and XLY (consumer discretionary sector) to that list. A sustainable rally will require the participation of XLF, XHB, and XLY.
Saturday, November 15, 2008
As representatives of the G20 assemble in Washington to discuss the state of the global economy, this seems like a good time to take the wraps off of the VIX and More Global Volatility Index.
Without getting into all the details, the Global Volatility Index calculates a weighted average of the implied volatility in options for equities in the 15 largest global economies, which represent approximately 76% of the world’s economic activity.
To the best of my knowledge, this index is the first of its kind, with previous volatility indices limited to country-specific volatility or in the case of the VSTOXX, to the Eurozone area.
The chart below plots the Global Volatility Index against the Dow Jones World Stock Index over the course of the past year. The Global Volatility Index opens up many new areas of analysis and interpretation of the markets and I will talk more about these in this space in the coming weeks.
[source: VIX and More]