Tuesday, December 31, 2013

VIX Futures Term Structure in 2013 Looks a Lot Like 2012

This was a very quiet year for the VIX, with the volatility index posting its second narrowest range for the year since 1995, trailing only 2005, when the Greenspan liquidity flood overwhelmed even the mere thought of a meaningful correction.

The graphic below shows the average (mean) normalized term structure for each year since the VIX futures were launched, back in 2004. In normalizing the data, I have set the average front month VIX futures contract to 100 and have expressed the averages of the second through seven months as multiples of the front month.

[source(s): CBOE Futures Exchange (CFE)]

Note that although the VIX futures were launched in 2004, consecutive VIX futures contracts for the first six months were not available until October 2006, hence the dotted lines for these years to reflect the erratic nature of the data. Interestingly, the lower VIX years of 2005 and 2006 did not produce the steep term structure that we saw in 2012 and saw again in 2013. Last year I described the 2012 VIX futures term structure as a statistical outlier, but now that 2013 data is in the books, it may be more appropriate to think about how the markets might have changed in the last two years, with potential causes that range from the VIX ETPs, more interest in trading volatility products, the rise of weekly options and other developments.

In the next few days I will devote a series of posts to analyzing some VIX, volatility and related data for 2013, then as 2014 unfolds I will offer some thoughts on how some of these markets are changing and evolving.

At the very least, I expect to ramp up my posting substantially in 2014, now that I have my investment management business up and running and find it easier to wear multiple hats at the same time.

Happy New Year!

Related posts:

Disclosure(s): none

Sunday, November 3, 2013

The Evolution of the Holiday Effect in VIX Futures

[The following originally appeared in the November 2012 edition of Expiring Monthly: The Option Traders Journal. I thought the contents might be timely in light of the upcoming holiday season.]

With fewer trading days and a historical record that favors an uptick in stocks and a downtick in volatility, the end of the year never fails to present an intriguing set of trading opportunities.

One phenomenon related to the above is something I have labeled the “holiday effect,” which is the tendency of the CBOE Volatility Index (VIX) December futures to trade at a discount to the midpoint of the VIX November and January futures.

This article provides some historical analysis of the holiday effect and analyzes how the holiday effect has been manifest and evolved over the course of the past few years.

Background and Context on the Holiday Effect on the VIX Index

Part of the explanation for the holiday effect is embedded in the historical record. For instance, in eight of the last twenty years, the VIX index has made its annual low during the month of December. In fact, the VIX has demonstrated a marked tendency to decline steadily for the first 17 trading days of the month, as shown below in Figure 1, which uses normalized VIX December data to compare all VIX values for each trading day dating back to 1990. Not surprisingly, those 17 trading days neatly coincide with the typical number of December trading days in advance of the Christmas holiday.

{Figure 1: The Composite December VIX Index, 1990-2011 (source: CBOE Futures Exchange, VIX and More)}

Readers should also note that, on average, the steepest decline in the VIX usually occurs from the middle of the month right up to the Christmas holiday.

The December VIX Futures Angle

Most VIX traders are aware of the tendency of implied volatility in general and the VIX in particular to decline in December. As a result, since the launch of VIX futures in 2004, there has usually been a noticeable dip in the VIX futures term structure curve for the month of December. Figure 2 below is a snapshot of the VIX futures curve from September 12, 2012. Here I have added a dotted black line to show what a linear interpolation of the December VIX futures would look like, with the green line showing the 0.50 point differential between the actual December VIX futures settlement value of 20.40 on that date and the 20.90 interpolated value, which is derived from the November and January VIX futures contracts. (Apart from the distortions present in the December VIX futures, a linear interpolation utilizing the first and third month VIX futures normally provides an excellent estimate of the value of the second month VIX futures.)

{Figure 2: VIX Futures Curve from September 12, 2012 Showing Holiday Effect (source: CBOE Futures Exchange, VIX and More)}

Looking at the full record of historical data, the mean holiday effect for all days in which the November, December and January futures traded is 1.87%, which means that the December VIX futures have been, on average, 1.87% lower than the value predicted by a linear interpolation of the November and January VIX futures. Further analysis reveals that on 91% of all trading days, the December VIX futures are lower than their November-January interpolated value. The holiday effect, therefore, is persistent and substantial.

The History of the Holiday Effect in the December VIX Futures

Determining whether the holiday effect is statistically significant is a more daunting task, as there are only six holiday seasons from which one can derive meaningful VIX futures data. Figure 3 shows the monthly average VIX December futures (solid blue line) as well as the midpoint of the November and the January VIX futures (dotted red line) for each month since the VIX futures consecutive contracts were launched in October 2006. Here the green bars represent the magnitude of the holiday effect expressed in percentage terms, with the sign inverted (i.e., a +2% holiday effect means that the VIX December futures would be 2% below the interpolated value derived from November and January futures.)

{Figure 3: VIX December Futures Holiday Effect, 2006-2012 (source: CBOE Futures Exchange, VIX and More)}

Conclusions

With limited data from which to draw conclusions, it is tempting to eyeball the data and look for emerging patterns which may repeat in the future. Clearly one pattern is that an elevated or rising VIX appears to coincide with a larger magnitude holiday effect, whereas a depressed or falling VIX is consistent with a smaller holiday effect. The data is much less compelling when one tries to determine whether the time remaining until the holiday season has an influence on the magnitude of the holiday effect. While one might expect the holiday effect to become magnified later in the season, the evidence to support this hypothesis is scant at this stage.

To sum up, investors have readily accepted that a lower VIX is warranted for December and the downward blip in December for the VIX futures term structure reflects this thinking. As far as whether this seasonal anomaly is tradable, there is still a limited amount of data – not to mention some highly unusual volatility years – from which to develop and back test a robust VIX futures strategy designed to capture the holiday effect.

In terms of trading the holiday effect for the remainder of the year, the coming holiday season is also complicated by matters such as the fiscal cliff deadline and various euro zone milestones that are set for early 2013. In fact, there may not be a reasonable equivalent since the Y2K fears in late 1999 that turned out to be a volatility non-event when the calendar flipped to 2000.

While the opportunities to capitalize on the 2012 holiday effect may be difficult to pinpoint and fleeting, all investors should be attuned to seasonal volatility cycles as 2013 unfolds and volatility expectations ebb and flow with the news cycle as well as the calendar.

Related posts:

Other articles republished from Expiring Monthly:

Disclosure(s): none

Thursday, October 31, 2013

Halloween Monsters

In the spirit of the day and lacking the resources and imagination to do something as elaborate as the Guillermo del Toro couch intro for the 2013 Treehouse of Horrors episode of The Simpsons (definitely worth a click through) I have elected instead to construct a portfolio of what I am calling the Halloween Monsters – a group of ten stocks that have been absolutely killing it this year, leading the markets higher.

The list includes the following familiar momentum names:

I intentionally left off Google (GOOG), in spite of an excellent 2013, largely because this behemoth now has a $346 billion market capitalization and there are some limits on how quickly on organization this size can grow.

With the inclusion of Baidu, the list reminded me a little of something I did back in October 2007, when I sensed a little too much froth in the stock market and created something I called the OHFdex, which began as a “watch list of Overripe High Fliers” and quickly evolved into an index designed to track 14 such stocks. When the markets turned down, the group was pummeled, with some spectacular crashes from the likes of CROCS (CROX), Las Vegas Sands (LVS), DryShips (DRYS) and others.

The current list is certainly filled with high fliers, but whether they are overripe or capable of soaring higher is not as obvious as it was in October 2007 – at least for me. For that reason, I will keep a close eye on the Halloween Monsters portfolio going forward, as their movements will likely be a tip off as to where the broader markets are headed.

[source(s): Finviz.com]

At the very least, I expect the stocks on this list to offer some interesting fodder for the archives, just as the OHFdex did in 2007 and 2008. Who knows, perhaps the next iteration of the OHFdex is just around the corner.

For more on the OHFdex and similar flights of fancy, check out the links below.

Related posts:

Disclosure(s): none

Thursday, October 24, 2013

The New VXST and the VXST:VIX Ratio

At the beginning of the month several interesting announcements came out of the CBOE Risk Management Conference in Portugal. One which particularly caught my interest was the announcement of the launch of the new CBOE Short-Term Volatility Index (VXST), which is essentially identical to the VIX, except that whereas the VIX is looking ahead at a window of 30 calendar days, the VXST measures implied volatility of options on the S&P 500 index (SPX) for the next 9 calendar days.

This means that the CBOE now has three different indices to measure implied volatility expectations in SPX options:

  • 9 days (VXST)
  • 30 days (VIX)
  • 93 days (VXV)

The VXV has been a favorite subject of mine going back to my initial comments on the index and the VIX:VXV ratio I pioneered as an indicator back in December 2007. With the new VXST, investors now have a better gauge of volatility expectations to apply to time frames that are appropriate for weekly options, which are on track to account for about 25% of all options trades by the end of the year.

The launch of VXST options opens up a whole new set of possibilities, not the least of which is a VXST:VIX ratio that offers some possibilities as an indicator that are similar to those of the VIX:VXV ratio. In the chart below, I have mapped not the ratio of VXST:VIX, but the differential between the two indices. With VXST historical data going back to the beginning of 2011, it is worth noting that the VIX has been higher than VXST about 61% of the time. Typically, when volatility spikes, VXST spikes much higher than the VIX, with the bulk of the 39% of the instances in which VXST is higher than VIX occurring mostly during periods of elevated volatility.

[source(s): CBOE, VIX and More]

I will go into much greater detail regarding VXST:VIX vs. VIX:VXV at a later point. For now it is worth noting that these ratios have some advantage to comparing the VIX futures term structure in that the indices focus on a fixed time period, while the days to expiration of the VIX futures is constantly in flux.

Also of interest, the CBOE press release notes:

“Plans call for CBOE and CBOE Futures Exchange, LLC (CFE®) to introduce VXST Weeklys options and futures. The launch dates for these tradable VXST products are yet to be determined, pending regulatory approval.”

As compelling as VIX products are for trading, I can imagine that VXST options and futures might be even more attractive to certain types of traders. Also, if VXST futures gain some traction, I can envision ETPs based on these that might rival the interest in VXX at some point.

In other words, this could easily turn out to be a huge development in the volatility space.

Related posts:

Disclosure(s): short VXX at time of writing; the CBOE is an advertiser on VIX and More

Wednesday, October 23, 2013

Performance of VIX ETPs During the Recent Debt Ceiling Crisis

Since the first big wave of VIX ETPs hit in 2010, I have periodically plotted all these products on a grid that used the y-axis for leverage and the x-axis for target maturity. While the initial intent was to highlight roll yield risk and leverage/compounding risk, over time I was unable to resist the urge to indicate which ETPs were optionable, which had both long and short legs, which had legs that were dynamically allocated, which had non-VIX components, etc. In other words, I fell victim to my unceasing need to try to tell an entire story on one slide, no doubt due in part to having seen too many 80-page presentations put together by consulting teams…

That being said, today’s iteration of my graphical depiction (“field guide”) of the VIX ETP universe is somewhat of a compromise. This compromise is due in part to the proliferation of VIX ETPs that combine long and short legs and have those legs dynamically allocated. The first of these to launch (back on August 31, 2010) was the Barclays ETN+ S&P VEQTOR ETN (VQT), which was followed by the First Trust CBOE S&P 500 Tail Hedge Fund ETF (VIXH) on August 29, 2012 and later by the PowerShares S&P 500Downside Hedged Portfolio (PHDG) on December 6, 2012. The field became considerably more crowded this year when VelocityShares launched the Tail Risk Hedged Large Cap ETF (TRSK) and the Volatility Hedged Large Cap ETF (SPXH) on June 24, 2013.

Rather than cramming these five similar products into the same narrow space, I have separated them from the grid and given them their own “VIX Strategy ETPs” box. With VIXH and PHDG now having a reasonable body of historical data to analyze, I have had a fair amount to say about these products already and will have more to say about them in the near future. TRSK and SPXH present an entirely different approach to hedging with volatility products and I will devote a separate post to these in short order.

In the meantime, the graphic below shows the performance of all the VIX and volatility ETPs from September 20 (when the VIX closed at 13.12) to October 8 (when the VIX closed at 20.34), when the VIX spiked 55% increase in just 12 trading days. As the graphic shows, for the most part the higher the leverage and the shorter the duration, the better the VIX ETP performed during the crisis. The performance of the VIX strategy ETPs was a mixed bag, with only TRSK posting a gain during this period. Another perennial hedging favorite, XVZ, also posted a gain.

[source(s): CBOE, Yahoo, VIX and More]

The trick with these hedges is one of timing.  As has been noted here on many instances in the past, the top performers in a crisis are typically those which are ravaged by price decay due to roll yield and/or compounding when the VIX does not spike. Compare the winners and losers in the graphic below with the winners and losers tallied in VIX ETP Performance in 2012 to gets a sense of how expensive it can be to carry speculative long volatility positions as well as more dynamic hedging positions over the course of an extended period. The bottom line is that it is almost impossible to create a VIX ETP that will perform well when the VIX spikes and when there is below average volatility or expectations of future volatility.

This is not to say that it is impossible to time long and short volatility positions in order to be positioned to take advantage of increases and decreases in volatility, only that most buy-and-hold scenarios have a negative long-term expectation and timing the volatility market is probably more difficult than timing the equities market.

The bottom line is that if you think Democrats and Republicans might have some difficulty navigating the January 15 deadline for funding the government or the February 7 deadline for raising the debt ceiling once again, then look no farther than the graphic above for some ideas about how to trade these events.

Related posts:

Disclosure(s): none

Tuesday, October 8, 2013

A History of the VIX During Recent Debt Ceiling and Sequestration Battles

Democrats and Republicans have been fighting over budgets and related matters since before any of us were born and while the debate has been heated at times, only recently has the credit of U.S. debt been called into question as a result.

During the impasse that led to the government shutdowns of November 14 – 19, 1995 and December 16, 1995 – January 6, 1996, for instance, there was nary a whiff of panic in the air, as the VIX never made it above 15 and spent a good portion of the shutdown in the 10s.

The last three instances of party budget squabbling have been much different than the Clinton-era budgetary battles and one only has to watch the trajectory of the VIX during these battles to get a sense of the uncertainty, anxiety and risk that was priced into SPX options during the period. Granted, none of these budget and debt ceiling battles has unfolded in a vacuum and the August 2011 debt ceiling battle played out against the backdrop of a dramatic worsening of the situation in Greece and euro zone sovereign debt in general, but the relative moves in the VIX during these three crises can still be instructive.

The chart below captures the month leading up to as well as data following the following three budget battles, all of which had specific deadlines, which are identified in the chart by the vertical black line running through day zero:

  • the August 2011 debt ceiling crisis
  • the December 2012 sequestration crisis (fiscal cliff)
  • the current debt ceiling crisis

Note that the August 2011 debt ceiling crisis is a classic example of risks that turned out to be much greater than almost everyone had predicted, whereas the fears related to the December 2012 sequestration crisis quickly disappeared. Historically there have been many more false alarms than crises which have escalated out of control, which is part of the reason why investors tend to underestimate and/or discount the full potential of each threat and why the VIX has a tendency to spike and then mean revert fairly quickly.

With a little over a week before the October 17 debt ceiling deadline hits, the VIX is higher now than it was at a similar stage in July 2011 or December 2012. Certainly the political landscape has changed since the last two budget battles and both the Democrats and Republicans have had an opportunity to refine their strategies and tactics in the interim. How it all plays out this week and next is anyone’s guess. I still find it hard to believe that there will be a default, but that still leaves plenty of room for the type of “resolution” that drags out the current anxieties and leads to additional pitched battles – some of which may be even more costly – down the road.

So by all means root for a replay of December 2012, but prepare for August 2011 just in case…

[source(s): CBOE, VIX and More]

Related posts:

Disclosure(s): none

Friday, October 4, 2013

Event Risk, Event Theta and the Next Week

Weekends pose an interesting set of problems for the investor/trader, particularly when there is an ongoing crisis or a reasonable risk that a new crisis lurks around the corner. Today we have a perplexing situation in which there is both an old crisis (government shutdown) and a new crisis just around the corner (debt ceiling limit), as well as the increasing likelihood that the two of these are going to merge into one bigger crisis.

How should an investor think about this situation? First, they need to form some opinions about event risk, including a range of scenarios from a quick and comprehensive resolution of the government shutdown and the debt ceiling to prolonged gridlock that results in the U.S. defaulting on its obligations. The fun part is assigning probabilities to these scenarios, coming up with a probability weighted view of the future and making (semi-)rational decisions about portfolio protection and speculative opportunities after considering risk and potential reward. Sounds like a snap, doesn’t it?

Some investors may not fully appreciate that event risk or event volatility is a two-sided sword. Sure, there is risk that many of us have once again overestimated a bunch of elected lemmings officials and their ability to act in the best interests of their country and in so doing reprise those wonderful memories from August 2011, but there is also the risk that some progress – or even a small sign that the tide is turning – could unfold over the weekend and cause stocks to soar on Monday as short-sellers absorb the brunt of the damage. Attaching a meaningful probability to these scenarios may seem futile, but running through the scenarios in one’s head to see what the implications are is certainly worth a little bit of spare brainpower.

Just a few months before the 2011 debt ceiling crisis, there was the three-pronged crisis that hit Japan, combining an earthquake, tsunami and nuclear meltdown. I talked about this crisis in Fukushima Daiichi and Event Theta and even invented a new term, “event theta,” to describe whether the passage of time was a positive or negative development for those with positions in volatility or other instruments.

“As these events unfolded, seemingly like a slow-motion train wreck, I kept asking myself whether time was in favor of or working against the efforts of those who were trying to limit the damage to the nuclear facility and surrounding areas. In other words, was this a positive theta event (time in our favor) or a negative theta event (a fight against the clock.) Not being an expert in the field of nuclear energy and knowing that certain factors could spiral out of control quickly, but also knowing that efforts were underway to stabilize some of the processes in the plant, I was left to guessing whether current efforts were more likely to fall short and result in a vicious cycle or were expected to stem the problem and turn the tide in favor of the rescue team.

Knowing whether this was a positive or negative theta event also has substantial implications for investment strategies. From a hedging perspective, event theta could influence the selection of hedging vehicles, the anticipated timing for those hedges, how the hedges might be structured and what sort of prices might be appropriate. For the speculative investor, event theta can also help to determine the risk-reward payoff structure and how it varies over time. Anyone who trades in VIX futures and deals with the VIX term structure on a daily basis should have some insights into potential mismatches between event theta and term structure.”

I suspect that for most of this week, event theta has been negative, meaning that the passage of time without meaningful progress toward an agreement was bearish for equities and bullish for holders of long volatility positions. With the weekend coming up and another two plus days of the news cycle, polling data and behind-the-scenes strategizing, it may be that event theta is closer to neutral and perhaps even positive. This is not to say that shorts should cover their positions before today’s close or anyone with a long volatility position should close out their positions and take profits, only to point out that at least until markets open again on Monday, risk for longs and shorts is becoming more balanced and determining the risk-reward payoff for a variety of positions is a much more difficult proposition.

Before the weekend is upon us, investors may wish to give some thought to the 2011 debt ceiling crisis, the 2012 sequestration battle and the timeline for how the 2013 deadlock might play out. In the meantime the, graphic below [an excerpt from The Year in VIX and Volatility (2011)] and the links below that should provide some food for thought about these and a number of related issues.

[source(s): StockCharts.com, VIX and More]

Related posts:

Disclosure(s): none

Saturday, September 14, 2013

Revisiting the VIX:VXV Ratio

Two of my favorite bloggers, who hail from very different corners of the investment landscape, both happened to mention me in reference to the VIX:VXV ratio in the past few days.

On Wednesday, in A Buy Signal from the Option Market, Cam Hui of Humble Student of the Markets, noted that the VIX:VXV ratio had fallen below 0.92, where “it has provided reasonably good long entry points in the past.” Cam linked back to my first post on the VIX:VXV ratio from December 2007, which, I am fairly certain is the first time anyone ever mentioned the ratio and suggested that it might have some value as a market timing signal.

Today Russell Rhoads of the CBOE, whose Trading VIX Derivatives: Trading and Hedging Strategies Using VIX Futures, Options, and Exchange Traded Notes is undoubtedly the best book ever published on the VIX, also mentioned the VXV:VIX ratio in one of his weekly volatility columns, This Week in VIX Options and ETPs – 9/13/2013. Russell’s version of this ratio, VXV:VIX, flips the numerator and denominator, so his comments are the inverse of much of my analysis. “Note on the chart there are a few instances where the ratio of VXV to VIX falls below 1.0. That seems to coincide with a subsequent near term bottom in the stock market as well.”

I have literally dozens of posts on the VIX:VXV ratio going back to 2007 and while I have hand-picked a selection of posts below that focus on this subject, I could easily fill a book with data, interpretative overlays and trading strategy ideas based on VXV (essentially a 93-day version of the VIX) and its relation to VIX and other measures of volatility.

One of the more interesting issues related to the VIX:VXV ratio is how that ratio has moved up and down over the course of various volatility regimes. In the first two years of the ratio (2007 and 2008), the average (mean) ratio was 0.97 and 1.02; during the past two years, however, the average (mean) ratio has fallen all the way down to 0.87 and 0.90.

For about 1 ½ years following the launch of VXV, using absolute levels in the VIX:VXV ratio as bullish and bearish signals worked almost perfectly. One only has to look at VIX:VXV Ratio Moving Toward Bearish Zone to understand why it quickly gained so many fans. When the 2008 financial crisis hit and in the aftermath of the crisis, the VIX:VXV ratio began to look like just another broken indicator. Since that time, the VIX:VXV ratio has continued to be a very useful indicator, yet its value has been greater when studied in relative terms than absolute terms. Old rules, such as increasing long equity exposure when VIX:VXV fell to 0.92 or 0.90, proved to be of little help when the average of the ratio hovered around 0.90 instead of 1.00.

During the last two years, the VIX futures term structure has departed significantly from historical norms, as I have demonstrated in the likes of The 2012 VIX Futures Term Structure as an Outlier. Frankly, the 2013 version of the VIX futures term structure looks a lot more like the outlier 2012 data set than any previous year.

There are many ways to think about a ratio in relative terms. Using percentiles, standard deviations and short-term vs. long-term moving averages are just some of the ways that one can rethink the VIX:VXV ratio in relative terms. In the chart below, for instance, I have calculated the two-week moving average of the VIX:VXV ratio relative to the moving average for the past quarter. This keeps the data standardized around a mean of 1.00 and allows for a way to evaluate the ratio on a relative basis, regardless of whether the current volatility regime has depressed or lifted the ratio data for the full lookback period.  Note how extremes in this ratio of ratios has been an effective market timing signal over the course of the past eleven years.

[source(s): CBOE, VIX and More]

Given the scope of the issues that are related to VXV and the VIX:VXV ratio, I pledge to devote a good deal more space to these issues going forward, including the twists and turns in the VIX futures term structure, the use of the VIX:VXV ratio in determining the dynamic allocations for XVZ, etc.

For those who are doing some of their own research into these and some tangential subjects, the links below are an excellent point of departure.

Related posts:

[source(s): CBOE, Yahoo, VIX and More]

Best VIX/Volatility/Risk Conference of 2013?

I am going to go out on a limb and project that the second annual CBOE Risk Management Conference (RMC) Europe, which is held at the Penha Longa Resort in Sintra, Portugal from September 30 – October 2, will be the best conference of the year for those who are interested in the VIX, volatility, risk and other related subjects.

While RMC Europe has an impressive list of speakers and an agenda that should entice any VIX and More reader, the setting for this year’s RMC Europe event is almost impossible to top. I understand that rooms at the Penha Longa Resort are filling up quickly, so I urge any European readers other those who are interested in flying in some more far-flung destinations, to make reservations sooner rather than later.

Some of the speakers of note include:

  • William Brodsky, CBOE Executive Chairman
  • Paul Donovan, Global Economist at UBS
  • Gerry Fowler, Head of Equity and Derivatives Strategy at BNP Paribas
  • Buzz Gregory, Equity Derivatives Strategist at Goldman Sachs
  • Sheldon Natenberg, Co-Director of Education, Chicago Trading Company, LLC

Some of the sessions that caught my attention include:

  • The Volatility Surface: Skew and Term-Structure
  • VIX ETPs, Interrelationships between Volatility Markets and Implications for Investors and Traders
  • Beyond VIX: Trading Volatility and Variance Across Asset Classes
  • Trends in Institutional Options and Volatility Product Usage
  • Optimizing Portfolio Hedging Strategies 
  • Using Short Options Positions to Manage and Lower Volatility of an Equity Portfolio 
  • Panel on Volatility as an Asset Class

If you are looking for things to do outside of the conference, you can always head over the Nazare to find 100 foot waves to surf, take in the history and gastronomy of Lisbon (not to mention the local beverage opportunities ranging from Vinho Verde to port), or check out the scenic local golf options.

In the U.S., the RMC alternates between Florida in even years and southern California in odd years and is typically held in late February or March. Next year will mark the 30th annual installment of the U.S. version of the RMC and will run March 17 – 19 at the Hyatt Regency Coconut Point in Bonita Springs, Florida.

Much to my chagrin, I will not be attending RMC Europe this year, but I intend to be in Bonita Springs in March and also to find my way to wherever the 2014 RMC Europe event is being held, come hell or high water.

For those who do make it to RMC Europe, I would very much be interested in hearing about your experience and some of your key takeaways in the volatility space.

[source(s): StockCharts.com]

Related posts:

Disclosure(s): the CBOE is an advertiser on VIX and More; VIX and More is a sponsor of the CBOE Risk Management Conference

Thursday, August 29, 2013

Watching Two Key Emerging Markets Currencies

With Syria and the Fed grabbing most of the headlines in the last few days, I wonder how many people have emerging markets currencies at the top of their list of concerns. I am guessing few are poring over the likes of India (EPI), Indonesia (EIDO), Brazil (EWZ), Turkey (TUR), South Africa (EZA), Thailand (THD) and the Philippines (EPHE) on a daily basis. As a matter of fact, I would bet that very few people even know that there is an ETF dedicated to the Philippines.

While keeping an eye on country-specific equities is important, it is currency movements that are at the heart of the emerging markets problem right now. Of course, the issue with currencies is really little more than a downstream effect of rising interest rates in the U.S., which is a result of changing expectations about the Fed’s quantitative easing (QE) program. Since December 2008, the Fed has used a variety of policy instruments to keep interest rates as low as possible in the U.S. and has effectively driven capital to emerging markets, where higher-yield investments looked more attractive. As QE begins to unwind, the supply of easy money in emerging markets has suddenly come to a halt and countries with large current account deficits and loans denominated in dollars (which will be repaid in a local currency that is rapidly declining in value) are particularly vulnerable.

Since many equity investors do not have access to a full menu of currency crosses, I think it is important to note that there are ETPs that track two of the most important emerging markets currencies:

  • WisdomTree Indian Rupee ETF (ICN)
  • WisdomTree Brazilian Real ETF (BZF)

In the chart below I show the yield in the 10-Year U.S. Treasury Note (UST10Y) in the black line, along with a ratio of the Indian Rupee to the U.S. dollar (ICN:UUP) in orange, as well as a ratio of the Brazilian Real to the dollar (BZF:UUP) in green. Now these are a roll-your-own ratio of ETFs to ETFs rather than the exact currency crosses, but the charts are almost identical (and easily constructed at StockCharts.com), while the key takeaways are necessarily the same. Note that until May, ICN and BZF relative to the dollar appeared to be more positively correlated to U.S. interest rates than negatively correlated. As soon as interest rates began to rise at the beginning of May, both ICN and BZF began to rapidly lose ground against the dollar and the negative correlation with U.S. interest rates suddenly became very strong.

One last point worth noting is that the BZF:UUP ratio has seen a bounce during the course of the last week, while the ICN:UUP ratio continues to deteriorate, as there has been little to suggest that the Indian Rupee is stabilizing, even as Brazil improves somewhat.

[source(s): StockCharts.com]

For those who are interested in evaluating the risk and uncertainty in emerging markets in general, the recent VEXXM as a Measure of Emerging Markets Volatility and Risk is recommended reading for some background and information on VXEEM, the CBOE Emerging Markets ETF Volatility Index.

Related posts:

Disclosure(s): long EWZ at time of writing

Tuesday, August 20, 2013

Pricing of VIX August and September Calls

The monthly VIX futures and options expiration is a fascinating time from an options strategy perspective, as it marks the point in time in which VIX futures prices collide with the cash/spot VIX. Thanks to the VIX Special Opening Quotation (SOQ), that price collision is an inexact one, but for all practical purposes, the VIX front month futures and cash/spot index converge once every month, just after the open on a Wednesday thirty days before the standard monthly option in the S&P 500 Index options the following month.

To make things more interesting, the last day of trading for the front month VIX futures and options is the Tuesday session just prior to expiration.

All these product attributes make it difficult to navigate the complex waters of the VIX product platform just prior to expiration, but because the VIX is capable of such sudden sharp moves [see VIX All-Time Spike #11 (and a treasure trove of VIX spike data) for some details,] options prices have to include the possibility of a sudden VIX spike right up until the moment of expiration.

For these reasons, it is sometimes possible to sell VIX options for a surprisingly high premium right before expiration. In the graphic below, I have captured some data from the TD Ameritrade/thinkorswim platform that shows the prices of various VIX calls as of about 2:00 p.m. ET that expire tomorrow, with just more than two hours of trading left in these products. For comparison purposes, I have also included the September options for the same strikes, which will expire on September 18th.  For the record, at the time of this snapshot, the VIX was at 14.48 and the August VX futures (now available on the TD Ameritrade/thinkorswim platform as ticker /VXQ3) were at 14.43.

Note that the TD Ameritrade/thinkorswim platform includes information on the implied volatility calculated for these VIX calls as well as the estimated probability that these will expire out-of-the-money on September 18th. Theoretically at least, the VIX August 25 calls have a more than 1% of expiring in-the-money at tomorrow’s open, while there is more than a 5% chance that the VIX September 25 calls will expire in-the-money. With an implied volatility of 139%, the VIX September 25 calls are currently bid-ask at 0.25 – 0.30.

I am not recommending selling VIX calls just prior to expiration and I certainly would want anyone who is interested in these type of trades to start out with defined risk trades (e.g., bear call spreads) before considering trades with unlimited risk...but the possible trading opportunities are fascinating, to me at least.

[source(s): TD Ameritrade/thinkorswim]

For those interested in additional background on the VIX expiration and some potential trade ideas, the posts below should provide a good jumping off point.

Related posts:

Disclosure(s): neutral position in VIX via options at time of writing

Thursday, August 15, 2013

SPX Pullback Table: The Fall From 1709

I can’t remember the last time that the S&P 500 index pulled back a little from a recent high and I did not get at least one request to update the table below.

The last time I did this, just two months ago in All About the Pullback from SPX 1687, I also threw in a scatter plot and trend line to help compare all the pullbacks since the March 2009 low. This time around I think the table with the raw data will suffice; those in need of a graphical plot can always click through the link above.

It is worth noting that this is the fourth pullback of 2013 and even with the year less than two thirds over, there have been more pullbacks in 2013 than in each of the last three years. The corollary is that the magnitude of the pullbacks for 2013 has been relatively mild, with a 7.5% jolt from May through June pacing three pullbacks that were barely significant enough to warrant inclusion in the table. In contrast, each of the previous three years has seen one pullback of more than 10% – a threshold that usually triggers the “correction” label.

[source(s): Yahoo, VIX and More]

Finally, while I have not included any VIX data in this table, I find it interesting that the VIX has yet to rise above 15 during this pullback. In every other instance cited in the table, the VIX managed to climb above 18 at least once.

Disclosure(s): none

Wednesday, August 14, 2013

Expanded Performance of Volatility-Hedged and Related ETPs

When I recently assembled Top Posts of 2013 (Through First Half of Year), several themes jumped off the page. The top four posts of the year summarize what many investors have been worrying about this year:

  1. The Low Volatility Story in Pictures
  2. Four Years of SPX Pullbacks in One Plot
  3. VIX ETP Performance in 2012
  4. All-Time VIX Spike #11 (and a treasure trove of VIX spike data)

The issues are related to pullbacks in stocks, the VIX spikes associated with them, how to minimize portfolio volatility when these types of events happen and what the implications are for various VIX exchange-traded products.

With that backdrop and a stock market that has been looking fatigued while it has meandered sideways for the past month, quite a few investors are thinking about how to hedge a portfolio that has a long-equity bias. In the graphic below, I capture the recent performance of a number of ETPs which may be suitable for hedging that type of portfolio.

[source(s): StockCharts.com]

Interestingly, the performance of these securities appears to fall into three distinct groups.

The top group has two ETPs:

  • SPY (black line), included largely for reference purposes
  • Direxion S&P 500 RC Volatility Response Shares (VSPY), which employs a market timing mechanism that dynamically allocates between stocks and bonds according to measures of market volatility (blue-green line)

The second group contains the core of the VIX-based dynamic hedging products:

  • First Trust CBOE S&P 500 Tail Hedge Fund ETF (VIXH), which is essentially a portfolio consisting of 99-100% of SPY, augmented by a dynamic allocation of 0-1% of VIX options (light green line)
  • Barclays ETN+ S&P VEQTOR ETN (VQT), which has a dynamic allocation of VIX futures that fluctuates based on realized volatility and the trend in implied volatility (red line)
  • PowerShares S&P 500Downside Hedged Portfolio (PHDG), like VQT, has a dynamic allocation of VIX futures and is based on the S&P 500 Dynamic VEQTOR Index (dark purple line)

The bottom group includes two performers:

  • UBS ETRACS Daily Long-Short VIX ETN (XVIX), which is equivalent to a fixed allocation of a 100% long position in VXZ, offset by a 50% short position in VXX. I have included XVIX (aqua blue line) here largely to show how closely the performance corresponds to that of XVZ
  • iPath S&P 500 Dynamic VIX ETN (XVZ), utilizes the slope of the VIX:VXV ratio (SPX 30-day implied volatility to SPX 93-day implied volatility) to determine the dynamic allocation to short-term and medium-term VIX futures. In this case, the allocation to short-term VIX futures (think VXX) can be either long or short, while the allocation to medium-term VIX futures will always be long, though it is variable (fuchsia line)

Keep in mind that the most aggressive hedges are almost always the ones that underperform the most in bullish periods. If you want a very different look at how some of these products perform when stocks decline sharply, check out Performance of VIX ETP Hedges in Current Selloff.

The links below provide some background information on some of these products as well as performance data and should serve as excellent starting points for more comprehensive research.

Related posts:

Disclosure(s): long VQT and short VXX at time of writing

Friday, August 9, 2013

Fox Business TV Appearance on Gerri Willis Show

Last month I wrote a guest column for The Striking Price on behalf of Steven Sears at Barron’s, entitled: How to Spot Risk Early. That column has received a fair amount attention and yesterday it landed me on Fox Business with Gerri Willis of The Willis Report in a segment with the title, How to Foresee Trouble in the Markets.

I should point out that this was the first time I have done an interview via a remote studio link and the experience was a little unsettling, sitting in a dark room staring off into the blackness while being assaulted by two huge spotlights that seemed as if they could illuminate an entire baseball field for a night game. Without the benefit of a monitor of having any idea what the feed looked like, I found myself talking to a voice inside my head staring into the darkness with absolutely zero idea what the feed might look like on TV. Fortunately the result was not as bad as I had feared.

Related posts:

A full list of my Barron’s contributions:

Disclosure(s): none

Monday, August 5, 2013

Updates for Newsletter/Stock of the Week and EVALS; Launch of New Investment Management Business

Just a quick note to inform readers that I recently provided updates and some performance data for the VIX and More Newsletter and also for the EVALS model portfolio service:

Please note that going forward I will no longer be publicly updating performance data for EVALS or for the Stock of the Week due to a variety of factors related to the launch of my new investment management business. I will continue to offer the newsletter, which will still include the Stock of the Week selection; I will also continue to offer the EVALS model portfolio service and will be pleased to discuss current performance data privately. As soon as the launch of my new investment management business is finalized, I will highlight some of the particulars in this space.

Posting on the VIX and More blog should not be affected by any of these changes. In fact, I pledge to resume a more regular posting schedule in the weeks and months ahead.

Tuesday, July 16, 2013

Guest Columnist at The Striking Price for Barron’s: How to Spot Risk Early

Today’s guest column, How to Spot Risk Early, at The Striking Price on behalf of Steven Sears at Barron’s, is the eleventh time I have had the opportunity to write a column for Barron’s. Today’s column picks up on a theme I addressed in a March 2011 article in Expiring Monthly which was titled, Evaluating Volatility Across Asset Classes. In that 2011 article, I introduce the concept of a volatility compass as a framework for evaluating the different types of volatility spikes that were seen in the 2008 financial crisis, the euro zone crisis as of May 2010, the Arab Spring in March 2011, and the May 6, 2010 flash crash.

[Volatility compass showing different levels of volatility across asset classes during four recent spikes in volatility. Source(s):VIX and More]

In the 2011 article I provide an overview of my thinking as follows:

“It is my belief that a better understanding of the volatility picture across asset classes will yield a better grasp of volatility events and help to identify a number of favorable trading setups.”

Later on I conclude the article with the following thoughts:

“For those who have studied sector rotation strategies and methods for trading geography-based ETFs, some of the analytical techniques used in those two disciplines can be carried over to an analysis of cross asset class volatility.

Ultimately, the study of volatility has both a science and art component to it, but a cross asset class approach provides a more broad-based holistic view of the volatility landscape and adds a little more science to the mix.

At some point, volatility becomes the study largely of contagion and falling dominoes. I can say without hesitation that a multi-disciplinary approach is essential to understanding contagion and dominoes and that a cross asset class analytical framework supplemented by tools such as the volatility compass is an effective way to approach that subject.”

In today’s Barron’s article, I expand upon the idea of four types of volatility indices and address volatility indices that provide a snapshot of geographical uncertainty and risk as well as broader measures of uncertainty and risk across asset classes such as U.S. Treasury Notes and currencies.

I will have more on this subject in the future, but for those interested in researching some of these subjects, I have highlighted some previous posts on different ways of thinking about uncertainty, risk and volatility below.

Related posts:

A full list of my Barron’s contributions:

Disclosure(s): none

Tuesday, July 2, 2013

Charting the Recent Decline of the BRIC Components

U.S. stocks are mostly green in today’s session, though there is a good deal of red in global stocks, notably in emerging markets, where the popular EEM emerging markets ETF is down close to 1% as I type this and the Brazil (EWZ) is down more than 2%.

In the chart below, I plot the recent decline of the four large BRIC emerging market country ETFs: Brazil (EWZ); Russia (RSX); India (EPI); China (FXI). While all four country ETFs have declined between 8% and 20% during the past six weeks, the various woes afflicting each country appear to be country-specific to a large extent, though obviously the issues affecting China’s manufacturing base and export market have a significant upstream impact on Brazil.

Emerging markets in general have been struggling as of late, but difficulties in Brazil, India and China have helped to fuel a global selloff.

Going forward, investors will be well-served to keep an eye on all four components of the BRIC block, as well as aggregated BRIC ETFs, such as the most popular issue in this space: the iShares MSCI BRIC Index (BKF).

For those who are interested in evaluating the risk and uncertainty in emerging markets in general, the recent VEXXM as a Measure of Emerging Markets Volatility and Risk is recommended reading for some background and information on VXEEM, the CBOE Emerging Markets ETF Volatility Index.

[source(s): StockCharts.com]

Related posts:

Disclosure(s): long EEM at time of writing

Monday, July 1, 2013

Top Posts of 2013 (Through First Half of Year)

Every year I tabulate the most-read posts in this space as I find this exercise to be an excellent way to identify the issues that are resonating with readers and also to see how these issues evolve over time. These most-read posts also serve as easily accessible repositories of high-quality material for the benefit of new readers and long-term readers alike.

A number of themes seem to be top of mind for 2103 so far. Clearly the VIX ETPs and their construction and valuation quirks continue to be a huge issue, as is their performance during various volatility regimes. On a related note, low volatility ETPs generated considerable press and interest toward the beginning of the year and as volatility picked up in the second quarter, readers gravitated toward information on VIX spikes and various ways to measure and evaluate risk.

The posts below represent those that have been read by the highest number of unique readers during the first half of 2013. Farther down there are links to similar lists going back to 2008, along with several other “best of” type posts that I have flagged for archival purposes.

For the record, each year I also attach the hall of fame label to a handful of posts that I believe have particularly compelling and/or original content, regardless of readership.

Related posts:

Disclosure(s): none

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 © 2007-2017 Bill Luby. All rights reserved.
 
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