Friday, October 30, 2009

Pullback Surpasses 2009 Mean

While this might not provide a great deal of comfort to longs, I have updated the VIX and More Pullback Table to reflect today’s selloff. The table shows that the peak to trough drop of 67.98 points (6.2%) in the SPX has exceeded the 2009 average of 5.8%.

As noted previously, a 5.8% pullback from the SPX 1101 established a target low of 1037. Today the SPX has been as low as 1033.38.

Looking at the charts, I would expect to see additional support in the 1015-1020 level should the 1034 mark fail to hold. In the meantime, brave souls who heed the VIX spike history or the strangle pong strategy should have a long bias going forward.

For related posts, readers are encouraged to check out:

[Edit: data updated as of 3:10 ET]

VIX Up 26% to 31.20

For the record, the VIX only spiked more than 26% on two days during the financial crisis: September 29 and October 22, 2008.

Strangle Pong

For the moment at least, it appears as if the S&P 500 index has encountered strong resistance at 1100 and strong support just above 1040. Assuming these support and resistance levels can hold up for another three weeks – and that is admittedly a large assumption – then the current market environment sets up nicely for what I like to call “strangle pong” with November SPX options. Essentially, this is an approach where one assumes range-bound trading and sells near-the-money options when the underlying approaches one end or the other of the trading range.

The graphic below outlines one way to approach this type of trade. Specifically, it involves dividing the trading range into three zones (which do not have to be of equal size, they just happen to be in the diagram): an upper end of the trading range in which one sells calls; a lower end of the trading range in which one sells puts; and a neutral zone near the middle of the range in which one takes no action (or perhaps sells both puts and calls.)

In an ideal world, the underlying bounces back and forth between support and resistance just like the pioneering computer game and the options seller captures a high premium each time the underlying approaches the end of the range. Once both puts and calls have been sold, a strangle is established, with the maximum profit and loss zone being defined by the target trading range.

The most important determinant of success in a strangle pong trade is the trading range of the underlying during the life of the trade. Of secondary importance is the volatility of the underlying, where increased volatility will increase the price of the options sold and work against the options seller. This is a position’s vega and is something I will address in future posts.

There are a number of ways on which position risk can be managed, not the least of which is to “buy the wings” (offsetting long put positions below SPX 1040 and offsetting long call positions above 1100) and convert this position into an iron condor. According to the strangle pong approach, right now, with the SPX trading a little below 1050, would be a good time to initiate the first leg of this trade by shorting some SPX 1040 puts. Let’s see how the market moves in the next week or so; I will revisit this strangle pong trading approach at that time.

For additional posts on strangles, readers are encouraged to check out:

Thursday, October 29, 2009

The Calendar Effect and Time Decay

Since the beginning of last year, I have periodically discussed what I call “calendar reversion,” which is essentially a phenomenon caused by the fact that the VIX is priced according to the calendar, but only calculated during trading days. The long and the short of this chronological mismatch is that market makers tend to drop option prices (and implied volatility) on Fridays in anticipation of the coming weekend and raise them on Mondays.

Earlier today, Mark Sebastian of Option911 wrote the best article I have seen on this subject, How Option Time Premium Decays Over the Weekend, in which he detailed his experiences related to weekend time decay and how market makers account for this during the Friday trading day. If you want to understand options pricing dynamics and how to best synchronize a five day clock with a seven day clock, then Mark’s work is absolutely required reading.

Note that Mark’s blog is one of the 15 entries in my new (as of today) Favorite Options Blogs list in the right hand column of VIX and More. In the past couple of months I have found myself going out of my way to assemble a Friday links post in large part to highlight some of the interesting work coming out of several relatively new options blogs. Now that it is no longer just Daily Options Report and VIX and More talking about options, I will do the best I can to incorporate as much of the excellent new information and analysis that can be found in all corners of the blogosphere.

For more on calendar reversion, readers are encouraged to check out:

Wednesday, October 28, 2009

VIX Spike of 35% in Four Days Is Short-Term Buy Signal

It has been awhile since I posted one of my VIX studies and given the recent spike in the VIX, today’s action seemed like a good excuse to revisit the idea of VIX spikes as contrarian bullish mean reversion buying opportunities.

Today the VIX closed at 27.91, which is up 34.9% in the four trading days since Thursday’s close of 20.69. Over the course of the 20 year history of the VIX, the volatility index has posted close-to-close four day gains of 35% on 42 occasions. If you strip out the consecutive instances of +35% days, this leaves 27 instances in which the VIX crossed above +35% in four days. I have reproduced the full table of these 27 instances below for several reasons. First, the key takeaway is that from a timing perspective, a long SPX position entered after a 35% spike will generally perform best over the course of a five day time horizon. In the graphic below, the 27 instances average a five day gain of 1.99% vs. a typical five day SPX return of 0.14%, for a 1.85% net differential. While the net differential peaks at five days, it is apparent in just one day and persists for at least fifty trading days.

Not surprisingly, since we are talking about extremely volatile periods, quite a few of the returns are at the tail end of the distribution and are highlighted in green and red. In particular, this contrarian long strategy did an excellent job of timing the bounces off of the lows during the Asian financial crisis in 1997, the Russian financial crisis and Long-Term Capital Management crisis in 1998, the 9/11 World Trade Center attacks in 2001, as well as the technology bottom following the WorldCom bankruptcy filing in 2002.

In contrast to the excellent market timing above, it should also come as no surprise that the four long signals from September and October 2008 turned out to be disasters in the 20-100 day time frame. Over the course of a 3-10 day time horizon, however, these were excellent short-term trading opportunities from the long side. I do wish to point out, however, that if one strips out the last four rows of the tables, suddenly the 100 day time frame has a return of 6.86%, which is 2 ½ times that of the baseline (“census”) return. The obvious conclusion is that the VIX spike buy signal is quite reliable for the short-term, but not as reliable for over longer time frames. This is the key take away from the table and the reason I included the full data set. The secondary conclusion is that VIX spikes are generally good long setups as well, but here the risk is that it precedes a once in a generation or two meltdown that erases a decade or more of returns.

Finally, while it is nice to throw statistics at analogous historical situations, it is important to consider that all it takes is one rogue GDP number to throw a monkey wrench into an attractive set of statistics. Tomorrow should be interesting – and I expect the bulls will be putting a great deal of capital to work no matter how the GDP data falls.

For posts on related subjects, readers are encouraged to check out:

Disclosure: Short VIX at time of writing.

VIX Currently 20% Over 10 Day Moving Average

At 27.22, the CBOE Volatility Index (VIX) is currently at its highest level since the beginning of the month. Perhaps more importantly, the VIX is at its second highest level relative to its 10 day simple moving average (+20.0%) since the November 20, 2008 all-time high close of 80.86.

Short-term, this is a bullish oversold signal for stocks, but now investors have to be wary that the SPX has also broken its 50 day moving average level of 1050.

Some of my earlier analysis suggested a good target bottom for the SPX is in the 1037-1041 range. With a little more than 20 minutes to go in today’s session, we are just a couple of points away from the top of that range.

Disclosure: Short VIX at time of writing.

VIX Spike and VIX Futures Contango Means…

Sometimes I like to skate around some of the salient points of volatility rather than to try to hit readers over the head with them, but with the VIX now 16% over its 10 day simple moving average, I hope I am not the only one going short volatility. Specifically, anyone who has been paying attention to my comments about VXX should be looking at opportunities to get short this VIX ETN.

At the moment, not only do short VXX positions have mean reversion going for them, but even with the spiking VIX, the VIX futures are still in contango, meaning that they are upward sloping over time, with the second month more expensive than front month. The chart below shows that while the difference between the second month VIX futures and the front month VIX futures has been declining, it is still substantial, which translates into a meaningful negative roll yield that continues to work in the favor of shorts.

Finally, not too long ago VXX was difficult to short at most brokers. This is not the case any more…

For additional reading on this subject, readers should check out:

[source: FutureSource]

Disclosure: Short VIX and VXX at time of writing.

Tuesday, October 27, 2009

The Post of the Month: An Informal History of VIX and More

From time to time I like to look back in the archives of VIX and More to see what I was blogging about during certain past events and to see what issues readers were latching on to. In doing so, it occurred to me that it would be possible to assemble an informal history of VIX and More – and of volatility events in general – by capturing for posterity the most popular post for each month in the blog’s history.

When I redesign the blog, this list will have a permanent home, but for now readers may be interested in reviewing the most read posts for each month this blog has been up and running:


2007
January: What My Dog Can Tell Us About Volatility
February: Four Ways to Play VIX Options Following a Record 64% Move to 18.31
March: A Sentiment Primer (Long)
April: The McClellan Summation Index
May: How to Find the Spiker Before the Earnings Announcement
June: CBOE Put to Call Ratio Poised to Print Warning
July: Using the VIX as a Timing Tool for the SPY
August: Drilling Down on Sector Performance
September: VIX Futures and Recent Market Action
October: Correlation Ideation
November: Brian Overby on Trading VIX Options
December: Thinking About the VXV


2008
January: The Fallacy of the Bearish First Five Days
February: The VIX, VXV and Volatility Expectations
March: Volatility History Lesson: 1987
April: Ten Things Everyone Should Know About the VIX
May: Strong Bear Signal from VIX:VXV Ratio
June: SPY Put Volume Study
July: CBOE Launches “Oil VIX” (OVX)
August: Overview of the U.S. Volatility Indices
September: VIX Spikes and the 2002 Market Bottom
October: VXO Chart from 1987-1988 and Explanation of VIX vs. VXO
November: Prediction: Direxion Triple ETFs Will Revolutionize Day Trading
December: Watch the Baltic Dry Index in 2009


2009
January: Chart of the Week: Change of Trend in Cash Holdings?
February: Regional Banks in Trouble
March: The Possibility of a ‘Stealth Bottom’
April: Lost in Translation: VXX and VXZ
May: Lagging Semiconductor Index Suggests Caution
June: Chart of the Week: Might Recent Volume Bottom Doom Stocks?
July: Triple ETF Options Landscape
August: SPX 15% Over 200 Day Moving Average for First Time in Ten Years
September: Draft Trader Stage Development Model
October: Trader Stage Development Model – Version 2.0
November: Best Article on Dubai Debt Problem and Related Issues I Have Seen Yet
December: New Dr. Brett Series on Lessons for Developing Traders


2010
January: Chart of the Week: VXX Celebrates One Year of Futility
February: Mamis Overbought-Oversold Indicator
March: Some Favorite ETF Sites
April: Short-Term and Long-Term Implications of the 30% VIX Spike
May: Rule of 16 and VIX of 40
June: The Elusive Trading Range
July: VIX Futures Contango Bubble
August: Three Books for Approaching Behavioral Finance
September: The Education of a Trader
October:  VIX Sets Two New Records
November:  Measuring the Pullback
December:  VIX and the Week Before Christmas


2011
January:  The Year in VIX and Volatility (2010)
February:  Chart of the Week:  Flight to Safety ETPs
March:  Fukushima Daiichi and 'Event Theta'
April:  Initial Thoughts on Using the iPad for Trading
May:  SPX Pullback History, 2009-2011
June:  Economic Data vs. Expectations and Stock Prices
August:  VIX Term Structure Evolution Over Last Ten Days
September:  Front Two Months of VIX Futures Slip Back Into Contango
October:  Shrinking VIX Macro Cycles
November:  New VIX Backwardation Record
December:  December Is the Cruelest Month...for the VIX


2012
January:  Five Years of VIX and More
February:  Volatility Becomes Unhinged on Friday
March:  Dynamic VIX ETPs as Long-Term Hedges
April:  The Case for Selling Apple Puts
May:  A Million SPX Put Contracts Traded Today...a Contrarian Timing Signal
June:  Tracking the Fall in VIX Futures
July:  Chart of the Week:  VIX Reversal Signal Coming Soon?
August:  How Can the VIX Be 14 and Lower Than VIN and VIF?
September:  Updating the Legacy of Post-2009 Corrections
October:  Ratio of VIX to Realized Volatility Higher Than Any Year Since 1996
November:  How High Might the VIX Spike?
December:  Volatility During Crises


2013
January:  VIX ETP Performance in 2012
February:  All-Time VIX Spike #11 (and a treasure trove of VIX spike data)
March:  The Low Volatility Story in Pictures
April:  Four Years of SPX Pullbacks in One Plot
May:  The Fed, QE, the Economy and Goldilocks 2.0
June:  The Currency Carry Trade, DBV and Risk
July:  Charting the Recent Decline of the BRIC Components
August:  SPX Pullback Table:  The Fall from 1709
September:  Revisiting the VIX:VXV Ratio
October:  Event Risk, Event Theta and the Next Week


 [last updated 10/4/13]

Monday, October 26, 2009

Does the Pullback Have Legs?

With stocks starting to show some signs of stability in the last half hour of trading, the big question on the mind of investors is how far the current pullback is likely to extend.

In order to address this question, I have updated the (surprisingly popular) table I presented at the beginning of the month in Pullbacks in the 2009 Bull Market. The revised table now shows that the pullback which ran from September 23rd to October 2nd resulted in a 5.6% decline from peak to trough, making it the third largest pullback in the S&P 500 index in percentage terms since the beginning of the March rally.

A comparable pullback of 5.6% this time around would put the next bottom in the SPX at 1041. Using an average of 5.8% for the previous seven pullbacks would establish a target SPX bottom of 1037. In both scenarios, today’s low represents less than 60% of the expected distance to the target bottom.

So while we may not be putting in a near-term bottom today, a good guesstimate is that the SPX has about 25 points more to fall if it is to keep up with recent historical norms.

Breaking Down the Weakness in Transports

Yesterday’s Chart of the Week: Falling Transports looked at the recent weakness in the Dow Jones Transportation Average (DJTA) and included a study of the performance of the index relative to the S&P 500 index.

Today I am going to look under the hood of the DJTA and highlight four often overlooked transportation sub-sector indices:

  • Dow Jones US Railroad Index ($DJUSRR)
  • Dow Jones US Airlines Index ($DJUSAR)
  • Dow Jones US Trucking Index ($DJUSTR)
  • PHLX Marine Shipping Index ($SHX)

The chart below, which plots each of the above sub-sector indices as a percentage of the DJTA shows that airlines have been the biggest laggard relative to the broader transportation average over the course of the past month, while railroads and truckers have also not been able to keep pace with the DJTA as of late. The relative strength in the transportation sector has come from the marine shippers – a point that is bolstered by the recent strength in the Baltic Dry Index (not shown in the charts.)

While I have yet to see any ETFs for the railroad and trucking sectors, two ETFs that are available are the popular Claymore/Delta Global Shipping ETF (SEA) and the less active Claymore/NYSE Arca Airline (FAA).

For additional posts on the transports and their sub-sector indices, readers are encouraged to check out:

[source: StockCharts]

Sunday, October 25, 2009

Chart of the Week: Falling Transports

For the most part, last week saw some mild negative numbers in most of the major market indices. One particular index that is closely watched by many, however, was particularly hard hit. The Dow Jones Transportation Average (DJTA), an essential component of Dow Theory, fell 5.4% for the week and was particularly hard hit on Friday.

Before the market opened on Friday, two of the three railroads in the DJTA reported earnings and while the bottom line numbers were impressive, investors were spooked by substantial revenue declines. Burlington Northern Santa Fe (BNI) reported a quarterly revenue decline of 27% from the comparable quarter in 2008, while Union Pacific (UNP) reported a 24% drop in revenues for the same period. The weak revenue picture helped to push the DJTA to a loss of 3.5% on Friday and create what looks for now to be a provisional double top in the index in the chart of the week below.

While I am by no means a strict adherent to Dow Theory, I do think the transports are important to watch, particularly when they signal a different economic client than is being reported by the manufacturing sector. The transports will be an important sector to watch going forward.

[source: StockCharts]

Friday, October 23, 2009

Trading Resources: Print and Electronic Magazines

In keeping with the theme of thinking like a biotech firm and the trader development stage model, I thought it might be helpful to highlight some of the top trading magazines that help to keep new ideas flowing.

Five established monthly print magazines that traders might wish to check out include:

  • Technical Analysis of Stocks & Commodities – an excellent choice if you are interested in analyzing chart patterns, indicators and trading systems. This magazine is particularly useful if you wish to see the relevant TradeStation, eSignal, etc. code in addition to the analysis
  • Active Trader – has a strong technical analysis and trading strategy orientation. Expect to see lots of equity curves, including a regular Trading System Lab feature that uses the Wealth-Lab platform
  • Futures – a broad-based magazine that covers futures, options and forex, with features that emphasize trading strategies and include a healthy dose of options-related material
  • Tradersworld – competes in the same space as the three magazines above, but for whatever reason, has never made the same impression on me as the others
  • Stocks, Futures and Options Magazine – the only free magazine in this group, SFO focuses largely on macroeconomic trends and high-level issues related to trading

Two additional electronic magazines – both free – take a direct aim at the options market and offer more options and related comment than the print competition:

  • Futures and Options Trader – published monthly in PDF format by the Active Trader group, this is a solid resource for the beginning to intermediate options trader
  • Futures in Volatility – more of a newsletter than a magazine, this is a publication of the CBOE Futures Exchange (CFE) and targets volatility futures, specifically VIX futures. Included in each monthly issue is a commentary section authored by Larry McMillan

Next, I would be remiss in not pointing out two relatively new print/electronic hybrids, both free, that specialize in options content and are available quarterly:

  • Bernie Schaeffer’s SENTIMENT – published by Schaeffer’s Investment Research, SENTIMENT covers a wide range of options and market sentiment topics, with an appealing mix of features and resources. The magazine can be downloaded as a PDF or delivered to your analog mailbox
  • thinkMoney – a thinkorswim publication that is mailed to thinkorswim customers, but is available as a PDF to customers and non-customers at the thinkorswim web site. Some of the content is thinkorswim-specific, but there is information that is valuable to a general audience as well

Finally, I feel obligated to pay homage to two high profile casualties of the financial crisis:

  • Trader Monthly – the glossy lifestyle magazine that oozed trader bling and testosterone
  • Condé Nast Portfolio – the ambitious business-journalism-meets-hedge-fund-world publication that had its moments as a shining star, albeit briefly

Thursday, October 22, 2009

Disappointment Lurks as Volume Surges in VXX

At the beginning of the month, when I penned Why VXX Is Not a Good Short-Term or Long-Term Play, I figured that would likely be my last word on the subject. Well, I haven’t changed my mind, but I saw myself shaking my head more than a few times yesterday, when the volume in VXX surged to a new record, obliterating the old record by 50%.

Perhaps this time around the new VXX longs were expecting something different, but yesterday’s numbers just reinforce my earlier points. Sure, VXX gained 1.87% on the day, but the VIX gained 6.32%. In other words VXX longs participated in less than 30% of the VIX spike.

Moves like yesterday illustrate some of my thinking about why VXX is not a good short-term volatility play. As I have noted in the past:

“The VXX juice factor (VXX movement as a percentage of VIX movement) shows just how disappointing the performance of VXX relative to the VIX is when the VIX spikes. The bottom line is that when you need it most, VXX is at its worst in tracking the VIX.”

When it comes to speculative or hedging plays using volatility products, VIX options (or futures) are typically the best choice. For short volatility positions, particularly when you see a VIX spike, think about shorting VXX. Those who favor long VXX positions have the odds stacked against them.

For more on the shortcomings of VXX, readers are encouraged to check out:

[source: StockCharts]

Wednesday, October 21, 2009

Anchoring and a VIX of 20

I can’t quite decide whether to be delighted or puzzled that so many people seem to care that the CBOE Volatility Index (VIX) is approaching 20. In truth, I feel a little bit of each. When I started this blog, I decided to devote a fair amount of attention to this unusual statistic that very few people were aware of and most that did had stopped paying attention to out of boredom. Of course the VIX was at about 10 then, the markets were awash in liquidity, and following a volatility index felt about as useful as trying to estimate Usain Bolt’s times with a sundial.

Fast forward three years and many things have changed. I can certainly appreciate the role the VIX played in trying to help the masses quantify fear in the midst of the financial crisis. When the VIX hit 50, 60, 70 and 80, these new highs sent a message that the situation was getting worse – or that investors were willing to pay dearly to protect themselves from the many potential disaster scenarios looming on the horizon.

A funny thing happened when the markets started to recover. We started to hear a variety of opinions that the VIX was too low, that substantial risks still remained, etc. The “VIX is too low” argument has been heard for several months now, but it seems to be gathering steam as the VIX approaches 20.

More than 35 years ago, Amos Tversky and Daniel Kahneman wrote a seminal piece on anchoring called Judgment Under Uncertainty: Heuristics and Biases. In the words of the authors:

“In many situations, people make estimates by starting from an initial value that is adjusted to yield the final answer. The initial value, or starting point, may be suggested by the formulation of the problem, or it may be the result of a partial computation. In either case, adjustments are typically insufficient. That is, different starting points yield different estimates, which are biased toward the initial values. We call this phenomenon anchoring.”

This is the same line of thinking practiced by investors who watch GOOG hover around the 450 mark for week after week, thinking they will wait until the stock falls to 400 to buy it on the cheap. The problem is that when GOOG moves over 500, all that anchoring around the 450 has conditioned the brain to think that 500 is too expensive, no matter how much GOOG rallies from that level.

Turning to the VIX, not only have all those readings in the 30s, 40s and 50s been recently imprinted into the investor’s psyche, but so also has all the emotional turmoil associated with the financial crisis and stock market crash. Even if things are better, the argument goes, can they possibly be this much better so soon after the global financial system was teetering on the edge of a cliff? The short answer is that anchoring makes it difficult for many investors to adapt to new price ranges and a new set of circumstances as situations change. It is part of the reason why bulls cling to hope on the way down and perma-bears have difficulty changing their bias when the market bounces. Finally, it is why so many people seem to be incredulous that the VIX is almost down to 20.00 when the lifetime (20 year) moving average for the volatility index is 20.26. In terms of volatility, we are right at the VIX’s lifetime moving average, which means investors are pricing in an average amount of risk and uncertainty – in historical terms – at the moment.

Of course, if one were to be anchored in the last 12 months, the VIX would be at an all-time low. Conversely, if one were anchored in the period from 2004-2006, the VIX would be in the 99th percentile, almost at an all-time high.

So…pull up the anchor and set your sails for the new volatility environment.

[source: StockCharts]

Tuesday, October 20, 2009

Diving a Little Deeper into the Strategy-in-a-Box ETFs

I was sufficiently pleased by the response to my strategy-in-a-box ETFs post that it seems appropriate to launch a follow-up post to address several questions raised or implied by readers. The biggest issues seemed to revolve around the history, performance and holdings of these ETFs. It is also important to understand the nature of the index and/or strategy that the ETF seeks to replicate, as well as the timing and methodology used to rebalance the ETFs. For each of the six aforementioned strategy-in-a-box ETFs, I have therefore also included links to a profile/summary page; the prospectus; a current list of holdings; the Morningstar performance data; and the StockCharts gallery chart:

As noted on Sunday, all but LSC have at least two years of a track record. Normally I would not consider this to be a long time, but given that it covers both strong bull and bear markets, I believe it is an appropriate time period from which to draw some conclusions. Perhaps more interesting is the rebalance period, where quarterly rebalancing seems to be the norm. I have spent a fair amount of time playing with various rebalancing methods and at least in my experience, I find it difficult to gain a meaningful edge with quarterly rebalancing.

Finally, it looks as if the strategy-in-a-box moniker is here to stay. I guess it is just a matter of time before I roll out screw top, synthetic cork and real cork strategies. Perhaps then we can turn our attention to the next dimension, Jeroboam, Methuselah and Nebuchadnezzar strategies…

[For all of you who think I may be spending too much time near the fermentation tanks, it was only two years ago that my weekly volatility analysis came with a wine pairing…]

Monday, October 19, 2009

VIX Narrowly Misses New Consecutive Day Decline Record

After falling for a record-tying ten consecutive days, the VIX narrowly missed setting a new record today when it jumped 0.37 in the 4:00 - 4:15 p.m. ET twilight zone trading period to finish the day at 21.49, +0.06.

In the chart below, which I borrowed from the subscriber newsletter, I offer some data to help put the current decline in an appropriate historical context. Prior to the streak that ended last Friday, the only other time that the VIX fell for ten consecutive days was in April to May of 2005. At that time, the bull market was just beginning to pause for a month and it was not until six months later that bulls began to reassert themselves.

Looking at the other fifteen instances in which the VIX fell at least seven days in a row, a pattern emerges in which following the VIX streak, the S&P 500 index has a tendency to post a slight loss for a week or so, then significantly outperform the historical averages (“census”) for the balance of the periods studied, from 10 to 100 trading days.

In terms of adding an interpretive narrative, think of a streak of the VIX declining for seven or more days in a row as a signal that the markets are recalibrating volatility expectations and paving the way for further advances in an environment of diminished risk. Of course the caveat is that a week or so of mean reversion (i.e., an increasing VIX and a declining SPX) usually serves as a transition from the streak of VIX declines to an extended period of above-average stock market returns.

For a related post, readers are encouraged to check out Steaking – an early VIX and More classic and also an official lighter side selection.

Sunday, October 18, 2009

Chart of the Week: Strategy-in-a-Box ETFs

With interest growing in actively managed ETFs, there is another category of ETFs (and ETNs) out there which I believe has been unfairly overlooked by most investors. I do not have a name for these ETFs, but rather than represent asset classes, sectors, geographies, and other typical ETF constructs, they seek to replicate specific investment strategies. Until someone tags them with a better name, I am going to call them strategy-in-a-box ETFs.

Depending upon how you define the strategy-in-a-box concept, you can find various ETFs that may or may not conform to that definition, but six that clearly fit the profile, have attracted some investor interest and that I try to monitor are:

  • Elements S&P CTI ETN (LSC) – a long-short commodity technical momentum ETF
  • Claymore/Sabrient Insider ETF (NFO) – targets companies where there are favorable corporate insider buying trends and recent earnings estimate increases by Wall Street analysts
  • PowerShares DWA Technical Leaders (PDP) – focuses on companies exhibiting strong relative strength as measured by Dorsey Wright & Associates Technical Leaders Index
  • PowerShares Value Line Industry Rotation (PYH) – is based on the Value Line Industry Rotation Index, which is derived from Value Line’s measure of stock timeliness and industry timeliness
  • PowerShares Value Line Timeliness Select (PIV) – unlike the ETF above, utilizes three core Value Line ranking systems that incorporate timeliness, technical ranking and safety
  • Claymore/Zacks Country Rotation (CRO) – which attempts to track the Zacks Country Rotation Index

What can you do with this motley group of ETFs? For starters, since all have been around for at least 15 months (all but LSC for more than two years), you can see how some of these strategies have worked in real-time bull and bear market conditions. For instance, if you just happened to get bullish on March 9th, which of the above ETFs would have provided the best returns? The chart of the week below shows that the Claymore/Sabrient Insider ETF (NFO) has led the pack, more than doubling over the course of the past seven plus months. The second best performer has been CRO, the Claymore/Zachs Country Rotation ETF. The PowerShares DWA Technical Leaders (PDP) has returned about the same as the SPX during the bull market. Interestingly, the Elements S&P CTI ETN (LSC) has actually lost money during the strong bull market in stocks.

I will have more to say about these ETFs and about their actively managed ETF cousins going forward. In the meantime, feel free to suggest a better name than strategy-in-a-box…

[source: StockCharts]

Friday, October 16, 2009

Interesting ‘Pseudo VIX Buy-Write’ Trade Idea

Vance at VIX Based Trading runs a blog devoted largely to using the VIX as a market indicator and as a trading vehicle. I only recently discovered the blog, but have been impressed by the content. As a matter of fact, my favorite post so far just happened to pop up on my screen a few minutes ago. Titled Pseudo Buy-Write on VIX – Long 10 Oct Calls, Short 22.5 Oct Calls, the author describes an innovative way to approximate a VIX buy-write strategy using a vertical spread.

With all the great blogs I am still discovering, it looks as if I am going to have to expand my blogroll once again. Better yet, I think it might be more helpful if I were add a second options-specific blogroll…so look for that change over the weekend. Assuming, of course, the blogroll does not get bought out by Bloomberg first…

Thursday, October 15, 2009

TradeKing’s Options Screening Tools

When TradeKing launched their stock and options brokerage back in December 2005, I was one of the first to sign on. The promise was an inexpensive commission structure, some innovative tools and an emphasis on integrating social media themes into the online experience. In the almost four years since it was launched, TradeKing still differentiates their services along the original three themes and has made increasingly larger overtures to options traders, including a strong educational component.

I have always had a good experience with TradeKing, but I realized today that my account was now growing some moss from extended neglect on my part. Frankly, there have been two relatively basic issues that have kept me at arm’s length over the past few years:

  1. The biggest issue I have is the three hour maximum login period before the website automatically logs me off. As an active trader, unless I can leave my browser window open for a full trading session without having to worry about being timed out just before I want to make an important trade, then I am going to be an intermittent customer at best.

  2. A related issue is the TradeKing login process, which is not keystroke-driven, but mouse-based. This is undoubtedly attractive for the security conscious trader, but not for those who wish to automate the login process and/or never be automatically logged off in the first place.
For the record, I have no problem with enhanced security features, but it would be nice if customers could elect the level of security that is appropriate for their account.

In any event, in surfing around TradeKing, I could not help but notice that there is a liberal sprinkling of iVolatility tools, notably the Volatility Charts; Options Calculator; Probability Calculator; Options Scanner; and Options Strategy Scanner.

Tomorrow being the last trading day for equity options prior to expiration, I thought it might be interesting to use the TradeKing Advanced Options Scanner to give me some trading ideas. Specifically, I decided to look for one day buy-write (i.e., buy a stock and simultaneously sell a covered call) trades, using the scanner to identify near-the-money October calls with implied volatilities of 80 or more.

The top chart below shows the simple scan parameters I used and the bottom chart shows the results of that scan. Looking at out-of-the-money (OTM) calls, I see that Cubist Pharmaceuticals (CBST), which reported earnings after the bell, has October 20s for sale at 0.50, which represents a 2.51% return from today’s close. In fact, all the OTM calls on this list are from companies which reported after the market close today or are scheduled to report results tomorrow morning. Still, the Options Scanner runs in real time and may be able to identify a high potential buy-write opportunity after the open.

In sum, The TradeKing-iVolatility partnership makes some interesting tools available to TradeKing account holders. Going forward, I will be looking to incorporate more TradeKing tools and graphics into the blog.

[Edit: I note that one reader wondered whether this post was some sort of endorsement for TradeKing. On the contrary, my intent is to rotate through some of the main options brokers (thinkorswim, optionsXpress, OptionsHouse and TradeMonster) in order to highlight what I consider to be some of the better features, etc. and give people a feel for some of what is available from each of these brokers. That being said, TradeKing does advertise on the blog from time to time, but so also do all the other brokers listed above, save thinkorswim.]
For related posts on these subjects, readers are encouraged to check out:

[source: TradeKing]

Wednesday, October 14, 2009

Blogging Network a Better Buy Than BusinessWeek?

I consider myself a trader who happened to fall into blogging originally as a means to create a stimulating diversion during the slow portion of the trading day. Almost three years into blogging, there is now a newsletter and a book on the way (yes, it is still a work in process), so now it appears that I have become a de facto member of the electronic media to boot.

Of all the content that appears on the blog, one which I rarely talk about, but take great pride in, is the list of “Blogs I Frequent” I maintain in the right hand column. Of the 300 or so feeds I subscribe to, this is what I consider to be the 80 blogs that are absolutely essential reading. This eclectic group spans a broad range of issues and individual biases. Any one of them might lead a reader down some bumpy intellectual roads or occasional dead ends from time to time, but as a group, these voices are consistently my best sources for stimulating new information and ideas.

I was thinking about all of this when I read that Bloomberg bought BusinessWeek for a sum described as in the $2 million to $5 million range. Surely the aggregate value of my blogroll has to be at least that of BusinessWeek.

For fun – because this is just a stimulating diversion after all is said and done – I went to the How Much Is Your Blog Worth? feature at the Business Opportunities Weblog to get one opinion on the value of my blogroll. Using a valuation methodology based on Technorati linking data, the Business Opportunities Weblog was able calculate the value of 49 of the 80 blogs on my blogroll. The aggregate value for these 49 blogs was $3.9 million dollars and since I was unable to obtain values for such media heavyweights as Bespoke Investment Group, Zero Hedge, Calculated Risk and The Kirk Report, among others, I have little doubt that the value of my blogroll is north of the $5 million figure at the top end of the BusinessWeek range.

For the record, in honor of Casey Kasem, I have reproduced below a list of the VIX and More Top 40 Most Valuable Blogs.

Go ahead and read BusinessWeek, but clearly there is more value to be had here.

Bloomberg, you have my email address.

[source: Business Opportunities Weblog]

Tuesday, October 13, 2009

The 52 Week Lookback Period and New Highs - New Lows

Market breadth is a great tool. It can be used to evaluate momentum and also as a contrarian indicator to help identify potential market reversals. Various breadth indicators range from simple advance-decline indicators like the McClellan Summation Index, to measures of new highs and new lows, and beyond.

As I have seen a fair amount of comments related to new 52 week highs and lows in recent weeks, I wanted to point out what I hope is obvious to everyone looking at these charts. First, in many respects that 52 week time frame is an arbitrary lookback period. One could easily use a lookback period of 3 months, 6 months, 2009 year-to-date, 2 years or whatever. As it happens, 52 weeks is the conventional lookback period that is baked into almost all of the new high and new low data.

I mention all this because from October 1, 2008 to October 10, 2008 the SPX was in a free fall and dropped from 1167 to 839. As a result, a large number of stocks are making 52 week highs right now only because the lookback period no longer captures the values prior to the free fall.

So…keep a close eye on market breadth, but be wary of an artificial jump in new highs that shows new highs surging since the beginning of October. For the most part, this is a function of an arbitrary lookback period. Said another way, if you are going to be a student of technical analysis, but sure to study not just the recent data, but also the data that is scrolling off of the radar.

[graphic: StockCharts]

Monday, October 12, 2009

Implied Volatility Flat Ahead of Bank Earnings

With some very important earnings in the financial sector coming up this week (JPM on Wednesday; C and GS on Thursday; BAC and GE on Friday), I have been watching implied volatility (IV) in the sector very closely. Much to my surprise, implied volatility has not increased ahead of earnings, as is typically the case.

The chart below, courtesy of Livevol, shows six months of price and volatility activity in JPMorgan Chase (JPM), with the upper portion chart highlighting the last two earnings releases with the blue “E” icon. The bottom half of the chart plots 30-day implied volatility (red line) against 30-day historical volatility (light blue line) during the same period.

Note that just prior to the last two earnings reports, implied volatility rose due to the uncertainty and potential for higher volatility associated with an earnings surprise. This time around, however, the lack of movement in implied volatility – as well as the proximity of the IV level to historical volatility – suggests that investors are not expecting any surprises at all. In fact, this situation is not specific to JPMorgan, but is also mirrored at Citigroup, Bank of America, Goldman Sachs and even quasi-financial General Electric. Not surprisingly, the bank ETFs, such as KBE, and the financial sector ETF, XLF, show a similar pattern.

No matter how the current earnings season unfolds, it is difficult to imagine that there will not be any surprises. Investors who think implied volatility is underestimating the surprise potential for the banks may look to initiate long straddles or long strangles to take advantage of a potential increase in implied volatility – and hence options prices.

For some related posts on implied volatility in financials, readers are encouraged to check out:

[source: Livevol Pro]

Sunday, October 11, 2009

Chart of the Week: Two Bull Legs and Counting…

In the seven months since stocks bottomed and rallied some 61% (in the SPX) to current levels, there have been two distinct bull legs. The first leg began with the low close on March 9th (or intraday low on March 6th) and lasted just a little more than three months until the high close on June 11th. After a one month downturn, the second bull leg was launched on July 10th and persisted almost two and one half months until September 23rd. This time the pullback appears to have been more short-lived and has a provisional end date of October 2nd.

The three charts below – which collectively form this week's chart of the week – capture the sector performance relative to the SPX (the numbers are not in absolute terms) for the first two bull legs and also throws in the first week of what may turn out to be a third bull leg.

Note that in the first two bull legs, financials (XLF) were easily the top performing sector in both instances. Also, on both occasions it was the materials (XLB) and industrial (XLI) sectors that had clear separation from the rest of the sectors and were almost neck and neck for second and third. These three sectors clearly represent a top tier in terms of performance during the most pronounced 2009 bull moves. A second tier of consumer discretionary (XLY), technology (XLK) and energy stocks (XLE) has generally performed slightly above the baseline SPX. The bottom tier consists of three defensive sectors that typically only outperform the SPX in market downturns. In fact, these three sectors, health care (XLV), consumer staples (XLP) and utilities (XLU), were the top three performers during the June 11th to July 10th pullback.

Just for fun, I have added the last week of performance in the bottom chart. It is too early to draw conclusions for one week of upward movement, but so far the leading sector for October is energy. If the markets are to continue to set new highs for 2009, a big question will be whether the same sectors continue to lead or whether new leadership emerges. Personally, I do not expect that the same performance hierarchy that has characterized the last two bull legs to continue during the next month or two of upward moves. In fact, I would expect leadership to shift to the second tier in the form of technology, energy or consumer discretionary stocks. No matter what happens, it will be interesting to see how the broader market performs if financials start to lag the other sectors.

[source: StockCharts]

Some VIX and More Updates and Changes

Just a quick note to highlights some recent updates and changes and flag another one that is coming down the pike.

In no particular order…

  1. Most readers have probably noticed that I have transitioned to the Disqus comment system for the blog. I did this for several reasons, but at the top of the list were the ability to have multiple threaded discussions under each post and my growing lack of patience with comment spam, which Disqus seems to do a good job with.

  2. As I have promised to do on a quarterly basis, I have recently provided performance updates and some brief commentary for the subscriber newsletter and the EVALS long/short approach to trading ETFs. For the most recent updates, including more on the Stock of the Week (up 529% in 18 months), try:
  3. Sharp-eyed readers may have noticed that I have added a “Recommended Options Books” widget to the right hand column, just above the “VIX – Educational Posts” content area. The widget rotates four of my nine favorite options books. The full list can be found at Amazon: Favorite Options Books. Going forward, I will start reviewing options and other trading books.

  4. The need for easy access book recommendations (a frequent reader request via email) and other resources has persuaded me to expand the blog in order to incorporate much more ‘permanent’ content. My intent is to continue the blog in its current form, but augment it with easy to find permanent content areas that include a good deal of educational materials, groups of introductory posts on a variety of subjects, book reviews, links to a broad range of options and other investment resources, etc. I have no specific timetable, but the decision has finally been made in my head to move VIX and More from a quirky little corner of the blogosphere to more of a destination site covering options, market sentiment, ETFs and related subjects.

Thanks to all who have politely prodded me to beef up what I am offering. More – and better – content is coming…

Friday, October 9, 2009

Nobel Peace Prize Links

Once again favoring material that focuses on the VIX and volatility, options, market sentiment, and ETFs, here are some of the posts from around the blogosphere (loosely defined) during the past few days that have given me something to ponder:

Thursday, October 8, 2009

The Art of Doing (Almost) Nothing

Yesterday was a very strange day on the blog. For the first time in probably a year, I did not post at all on a trading day – and yet the blog set an all-time record for most hits in a single day.

Those seemingly incongruous two facts got me to thinking about my best day of trading. Ironically, on that day I did not make a single trade. Instead, I simply acted as a slightly bemused caretaker for several large positions that just happened to be moving in the right direction on the same day. As was the case with the blog, once again I did nothing and had my best results.

All this got brought me back to thinking about the trader development stage model and the importance of understanding how a trader spends his or her time. Is almost all of your time spent on researching “the next big thing” or uncovering penny stocks that are flying under the radar of the investment community? Do you obsess over every uptick and downtick of the stocks in your portfolio and check your portfolio balance even more often than you check for new email? If this sounds all too familiar, then I suspect you are mired in stage 1 of the trader stage development model and still have too much of a stock-centric view of trading.

A good trading day for me is one in which I make no trades. On those days I can devote almost my full attention to research and development. This means looking at things like new asset classes, new products, new exit rules, new strategies and new approaches to risk management. Next month my favorite strategies may stop working. While I have no idea which penny stocks may perform as well or better than my current approach, I already have a couple of promising strategies ready to be deployed that fit my personality, risk profile and strategic objectives.

So…how do you spend your trading day and what are the implications for long-terms investment success?

For related posts on this subject, readers are encouraged to check out:

Tuesday, October 6, 2009

VIX Defining a Range Between 22 and 30

The CBOE Volatility Index, which is usually referenced here by its ticker symbol, VIX, seems to be settling comfortably into a range between 22.00 and 30.00 that is has traded in since early July. Given that the relatively narrow eight point range has now held up for three months, there is a natural tendency to wonder whether the VIX has started to form a natural top and bottom that will result in an extended stay in this range.

The chart below tracks the daily movements in the VIX back to August 2008 and shows how the gravitational forces working on the VIX have pulled it back from just shy of 90 to the low to middle 20s. This is still above the 19.00 – 22.50 range that prevailed in August 2008, but not by a large margin.

Even with all the uncertainties surrounding the upcoming earnings season – which Alcoa (AA) technically kicks off after tomorrow’s close – I still think there is a strong probability that the VIX spends the balance of the year in the same range that it has been during the past three months. In fact, with earnings next week from the likes of General Electric (GE), Bank of America (BAC), Citigroup (C), JPMorgan Chase (JPM), Goldman Sachs (GS), Intel (INTC), International Business Machines (IBM), Johnson & Johnson (JNJ), CSX and others, I expect the tone for the balance of the year to be established in another 2-3 weeks, at most.

As volatility tends to escalate prior to earnings, there is a strong temptation sell some options – including VIX strangles – before the third quarter results start pouring in. I will have more on some VIX short strangle trading ideas in short order.

[source: StockCharts]

Monday, October 5, 2009

Trader Development Stage Model – Version 2.0

I was delighted to see the positive response to my draft trader development stage model, which I rolled out last Tuesday in a post with the unlikely title of Draft Trader Development Stage Model and put immediately to work in an option context in The Trader Development Stage Model and the Jump from Stocks to Options. Clearly this framework resonated with quite a few traders, from beginner to advanced.

With my penchant for not knowing when to leave something alone, I thought it might be helpful to expand upon the simplified version of the original trader stage development model and introduce a second version.

The graphic below adds only two new boxes (Technical Analysis and Strategy Management) to the original stage development model, but also adds some explanatory notes, labels for clarification (Issues, Theme and Unit of Focus) and further identifies each of the three stages with what I call Unit of Focus, but can also be interpreted as a Level of Abstraction or something similar.

As was the case the first time around, I am not going to spend too much time adding interpretive commentary other than to note that the two-way arrows represent tension between issues that are closely linked, sometimes because they compete with each other and other times because they are complementary. Also, while I never spelled it out the last time around, the background colors are meant to represent when the trader is likely losing money, breaking even and finally making a profit.

There is the potential to take this trader stage development model and get much more specific with it, use it as a diagnostic, etc. For now, the current level of detail is probably appropriate for most future applications I anticipate in this space.

As this is a mental model that is highly subjective, I would be glad to field to any feedback, criticisms, suggested enhancements, etc.

For more on the trader stage development model, readers are encouraged to check out:

Sunday, October 4, 2009

Chart of the Week: NASDAQ TRIN

The NASDAQ TRIN is an indicator I generally hear very little about, yet in a market where technology stocks have been leading many of the advances and decline, one that I believes deserves closer scrutiny.

In this week's chart of the week below, I show a simple NASDAQ TRIN chart that uses a 21 day exponential moving average to smooth out some of the daily noise that is common in short-term studies of this indicator. As a contrarian market sentiment indicator, the TRIN is useful for helping to identify market turning points or the potential for near-term reversals.

The chart below shows that since the markets settled down and bottomed in early March, the NASDAQ TRIN has been adept at signaling buying points (below the green horizontal line) and selling points (above the red horizontal line.) Friday’s EMA-smoothed reading of 1.28 is the highest since the mid-May bottom and suggests that the current pullback may be another good buying opportunity.

Whether or not you agree with the buy on the dip approach at the moment, you should make an effort to keep an eye on the NYSE TRIN (a.k.a. the Arms Index) and the NASDAQ TRIN as market timing signals.

For additional reading on the TRIN and the NASDAQ TRIN, readers are encouraged to check out:

[source: StockCharts]

Friday, October 2, 2009

Post-Employment Report Links

As is usually the case here, in these links I give preference to material that focuses on the VIX and volatility, options, market sentiment, and ETFs.

That being said, three areas that I will likely give more weight to going forward are behavioral economics, risk management and psychology. The expanding focus is largely because I believe the opportunity for improvement in these subjects is so much greater for most traders than it is in enhancing existing quantitative skill sets and the like.

Some of my favorite posts from the past few days:

Thursday, October 1, 2009

Why VXX Is Not a Good Short-Term or Long-Term Play

During the last month, the iPath S&P 500 VIX Short-Term Futures ETN (VXX) has been turning over an average of 1.3 million shares per day. I am certain that a fair portion of the purchases of VXX have come from investors who have sought to protect their portfolios from an increase in volatility and/or downturn in stocks.

Unfortunately, VXX has considerable shortcomings, both as a short-term and a long-term play.
Investors who are long VXX hope that when volatility increases dramatically, they will benefit by holding the short-term VIX ETN. In fact, when the VIX spikes 10% or more in one day, VXX generally does not cover even half of that move in percentage terms. The table below shows the eight instances since the January launch of VXX in which the VIX rose 10% or more in one day. The results speak for themselves, but in the eight instances over the course of eight months, VXX has been capturing only one third to two thirds of the VIX spike.

Ironically, when the VIX is flat or falls, VXX does a much better job of keeping pace. The VXX juice factor (VXX movement as a percentage of VIX movement) shows just how disappointing the performance of VXX relative to the VIX is when the VIX spikes. The bottom line is that when you need it most, VXX is at its worst in tracking the VIX.



VXX may be even less effective as a long-term holding. As previously discussed in VXX Calculations, VIX Futures and Time Decay, VXX suffers from negative roll yield when the VIX is in contango (when the front month VIX futures are less expensive than the second month futures), with the result that VXX loses a few cents each day due to rebalancing, just like a tire with a slow leak. This is why VXX is not able to sustain its value the way the VIX does. Today, for instance, the VIX closed at 28.27 and VXX closed at 52.35. Back on June 9th, the VIX also closed at 28.28, yet on that day VXX closed at 74.26. That 29.5% drop in VXX while the VIX held steady is largely the result of negative roll yield – and is evidence that VXX is usually not viable as a long-term holding.

I have discussed the movements of VXX in considerable detail in my subscriber newsletter, but for those who are interested in more information about VXX on the blog, some related posts include:

Pullbacks in the 2009 Bull Market

Nearing the halfway point in today’s trading session, the S&P 500 index has made an intraday low of 1036.38, which is below the recent September 25th low of 1041.17 and about 4.1% below the September 23rd high of 1080.15.

This 4.1% pullback is the seventh significant pullback since the current bull market began back in March. The table below summarizes all the pullbacks of 3.9% or more from the intraday highs to the intraday lows. The current pullback, highlighted in yellow, represents the second longest in terms of duration from the high to the low. As far as the magnitude of the pullback, however, 4.1% ranks sixth out of seven. The average (mean) pullback prior to the current one has been 5.84%. Applying an average pullback to the 1080.15 high would imply a pullback to about SPX 1017.

Some other technical factors have me looking for support in the 1020-1025 area. Should that support fail to materialize, I would not be surprised to see SPX 1017 taken out quickly and the SPX test 1000 in short order.

All things being equal, however, there is no reason to assume that the recent history of short and relatively shallow pullbacks should not continue into the future, with SPX 1100 a more likely next stop than SPX 1000.

DISCLAIMER: "VIX®" is a trademark of Chicago Board Options Exchange, Incorporated. Chicago Board Options Exchange, Incorporated is not affiliated with this website or this website's owner's or operators. CBOE assumes no responsibility for the accuracy or completeness or any other aspect of any content posted on this website by its operator or any third party. All content on this site is provided for informational and entertainment purposes only and is not intended as advice to buy or sell any securities. Stocks are difficult to trade; options are even harder. When it comes to VIX derivatives, don't fall into the trap of thinking that just because you can ride a horse, you can ride an alligator. Please do your own homework and accept full responsibility for any investment decisions you make. No content on this site can be used for commercial purposes without the prior written permission of the author. Copyright © 2007-2013 Bill Luby. All rights reserved.
 
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