Tuesday, February 27, 2007

How to Think About the Day After: Executive Summary

It looks like I am going to opt for some sleep over a long night of research, but before I head off to bed, I thought I would offer up some VIX-related bullet points for you to keep in mind as you watch trading unfold tomorrow and beyond:

  • most VIX spikes last one day and start to retrace on the 2nd day

  • the second most common VIX spike pattern is one of 3-5 days in duration before it starts to subside (note that the VIX had already jumped about 10% in the two days prior to today's 64% spike, which might make it even more susceptible to a retracement as early as tomorrow)

  • if the VIX can carry some upward momentum past a second week, it has a fairly high chance of heralding an extended period of much higher volatility

  • a very large majority of VIX moves run out of steam within 10-20 days of the original spike

  • more often than not, the best way to play the VIX is to bet on it reverting to the mean (i.e., 10 and 20 day SMA) after a 3-5 day spike

  • VIX options are *very* difficult to play because...

    • their prices are a function of VIX futures prices, not the underlying VIX prices -- so often the VIX moves a substantial amount in the direction you want, but the call or put moves a lot less or in the opposite direction because the futures expectations change much more slowly than the ‘spot’ VIX price

    • implied volatility in the VIX tends to be extremely high even in relatively placid markets, so swimming upstream faster than time decay can often be harder than it appears

    • if you must play VIX options, consider hedging your bets with some bear call spreads instead of or in addition to buying some puts outright


Unknown said...

Bill, thanks for your exhaustive work on the subject. Amazing stuff.

Bill Luby said...

Thanks, Jim. FWIW, your piece on China/Stratfor is still the most interesting piece I have read all day.

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