Showing posts with label Schaeffer. Show all posts
Showing posts with label Schaeffer. Show all posts

Tuesday, June 19, 2007

Should Bulls Root for a High VIX or a Low VIX?

About two months ago, several readers asked me if I thought the markets could continue to make new highs while the VIX hovered significantly above its all-time low. My answer then, an enthusiastic “Absolutely!” has not wavered. In the interim, I have even managed to accumulate two additional months of data to support my case.

Today Bernie Schaeffer is talking up the same theme, this time with a piece bearing the lengthy title of “An Elevated VIX Points to Continued Gains: Why the Rising CBOE Market Volatility Index (VIX) Signals Less Complacency.” With titles like that, it hardly seems worth the trouble to read the few extra words in the body of the article that didn’t make it into the title, so I will save you the effort by highlighting his main points:
“The ratcheting up of the low end of the CBOE Market Volatility range from single digits to the floor in the 12-12.50 zone that has prevailed since March is, in my opinion, a major positive for the sustainability of this bull market.
The fact that premium sellers are demanding more for assuming risk is a direct refutation of the "complacency" argument those looking to call a top are so fond of trotting out. And to the extent there is less premium selling activity, the "speed bumps" that are created at strikes with large open interest that can often slow rallies to a crawl are mitigated.”

In short, Schaeffer and I are pretty much on the same page here in thinking that an elevated VIX floor is a contrarian bullish signal for the markets.

The one point of contrast I do want to emphasize is in the chart Schaeffer uses to support his contention that a high VIX is a bullish signal for the markets. In his SPX and VIX chart, Schaeffer displays the classic pattern of VIX spikes almost perfectly correlated with short to intermediate-term bottoms in the SPX. While I take no issue at all with the 10 to 20 day mean reverting characteristics of the VIX that I probably discuss here too often, the point I want to re-emphasize is that the long-term correlation patterns between the SPX and the VIX are a lot more problematic. If you look at a monthly VIX chart I posted awhile back, you can see extended periods of time where the SPX and VIX are negatively correlated (2003-2007) and others where they are positively correlated (1995-1999.)

The bottom line is that it is important to keep in mind that the shorter the time-frame, the more likely the SPX and VIX are to be negatively correlated. In the short-term, therefore, bulls should be adding to their positions when the VIX spikes; over the longer term, however, I would not be surprised to see both the SPX and the VIX to be moving higher in tandem.

Thursday, March 22, 2007

Cherry Picking Other Opinions…and an Occasional Fact

The current installment of my survey of recent comments about life on the fringe of the VIXiverse and beyond:

Monday, February 26, 2007

“Let’s see if you bastards can do 90!”

About a month ago, I remarked on some comments from Doug Kass about how the markets looked a lot like 1994, which was a decidedly down year for equities. Now Bernie Schaeffer tells us that the WABAC machine (not to be confused with the highly entertaining internet archives ‘wayback machine’) should actually be set to 1995, not 1994.

The difference, of course, is substantial. In 1995, we saw the beginning of a glorious bull run that lasted through until early 2000. Those who loaded up on long positions in 1994 probably had a substantial hole to dig out of before they could enjoy the fruits of the 1995 bull – if they didn’t give up entirely in the interim.

In “Market Parallels with 1995,” Schaeffer makes the case for parallels with the beginning of the 1995 bull as follows:

“Joseph Keating, chief investment strategist at First American Asset Management, recently pointed out in an article that the SPX's price-to-earnings (P/E) ratio fell to 17 as of the third quarter of 2006 - lowest since mid-1995. Meanwhile, the SPX has now gone 221 days without a two-percent correction. This compares to the 223-day streak experienced in 1995.

Furthermore, we find the market in another in a low-volatility environment, as the CBOE Market Volatility Index (VXO) currently hovers around levels similar to those we saw in 1995. “

Personally, I think it looks more like 2017 than anything else. If forced to choose to match my outlook with one year over the other, I’d pick 1994 over 1995, but what do I know, I’m just living in my own little VIX-centric universe…

Tuesday, February 20, 2007

Puts, the VIX and Intra-Month Volatility

If he keeps it up, Bernie Schaeffer is in danger of garnering honorary VIX pundit status, due to his tendency to talk about the VIX almost as much as Adam Warner and I do. Today, Schaeffer discusses the monthly VIX cycle and ties it in with the recent low VIX readings as follows:

“…the relatively low VIX could entice a number of options players to snatch up put options when trading starts today in an effort to lock in some ‘cheap’ protection. This would put downside pressure on the market.

As we have seen in the past, while expiration week tends to be strong for the market, the week following option expiration is often marred by a pullback in the major indices. Frequently, traders will jump back into put positions now that their previous positions have expired. This swelling in bearish bets is accompanied by hedging among the traders who take the other side of that trade and sell the puts, another factor that creates downside pressure.

Turning to a chart of the VIX, I found that over the past year, VIX peaks have been in the first half of the month, with the very notable exception of May 2006 and also November 2006 (July 2006 is on the bubble).

Another way of framing this could be that in the post-expiration period each month (always in the second half), market performance is ‘challenged’ by the fact low VIX periods attract put buyers and stock sellers. A better explanation might be that the rise in the VIX from the second half of a typical month into a peak in the first half of the next month is the result of the accumulation of index puts in the new front month, with the VIX peaking (and selling pressure lifting) once all the put demand is satisfied.”

I made a similar observation on VIX price movements during the options expiration cycle, which was also supported by an examination of VIX prices during the quarterly earnings cycle.

Could cheap portfolio insurance and the options expiration cycle be part of a vicious circle for the VIX? If so, what happens when portfolio insurance gets more expensive and this circle is broken?

I will kick this one around a little and update my thinking here as it evolves.

Wednesday, February 14, 2007

Why is the VIX so Low?

A number of theories have been kicked around recently to explain why the VIX is at historical lows.

Justin Lahart re-ignited this debate with his comments in the WSJ yesterday in which he offered the explanation that:

“The VIX and other measures of implied volatility are low, in part, because investors are selling put and call options — ’selling volatility’ in Wall Street parlance. That helps to drive option prices — and implied volatility — even lower.”

Bernie Schaeffer takes issue with Lahart’s analysis this morning in, arguing against both the low VIX theory and the likelihood that selling volatility is the cause. Schaeffer cites the recent extremely tight trading range of the OEX as proof that the VIX can go much lower. He also maintains that a large majority of the option activity in question has been initiated by buyers, not sellers.

Striking a similar note, Adam at the Daily Options Report draws comparisons between the current VIX and the range-bound VIX of the early to mid-1990, suggesting that the 10-15 range may be the natural long-term range of the VIX.

As mentioned previously in this space, Jason Goepfert of has attempted to reconstruct the VIX going back all the way to 1900 and believes that the current VIX readings are not particularly low by the historical standards of the past century.

Finally, in my first entry in this blog, I proposed that the VIX had moved in four macro cycles in the 14 years since it first appeared, with a typical length of 3-5 years per cycle. According to my analysis, the current cycle of decreasing volatility began in April 2002, so the five years will be up in another two months or so.

I have no prediction for what will happen to volatility two months from now and beyond, but I will do my best to use this blog to present the various theories of why the VIX is low and refine my own thinking as I go along. In the meantime, I will continue to fade any large spikes and continue to work the bear call spread angle.

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