Sunday, September 30, 2007

VWSI at +4; Next Bump Soon?

So what’s with the round numbers? Surely the conspiracy theorists know that prior to last week the VIX had closed at a round number only 9 times in 18 years. Now that we have back to back closes at 19.00 and 18.00 the stars must be aligning for something. But what?

The VWSI, which is registering a reasonably elevated +4 on the heels of last week’s +6, thinks that a significant VIX spike is just around the corner. Back to back positive readings of this magnitude in the VWSI are extremely rare and with volatility below just about every moving average, this appears to be a good time to consider lightening up on equities and getting long volatility.

With the VIX dropping exactly one point (5.3%) this week to 18.00, we are now down to the lowest end of week reading in ten weeks. Like I said last week, with all the headline risk, the VIX looks like fairly cheap portfolio insurance.

(Note that in the above temperature gauge, the "bullish" and "bearish" labels apply to the VIX, not to the broader markets, which are usually negatively correlated with the VIX.)

Wine pairing: For a VWSI of +4 I heartily recommend a riesling. As a matter of fact, riesling is a wine that goes with just about any VWSI. It is versatile food wine that comes in a wide variety of styles, from bone dry to the sweetest of dessert wines . Frankly, this wine deserves to be more popular than chardonnay, but, at least in the United States, riesling’s stature has been weakened by too many associations with middling off-dry versions of the varietal.

German-speaking readers can find a wealth of information about riesling at; those who rely on English will have to be content with the likes of Riesling Report.

In terms of top producers, all of my comments about Alsatian gewurztraminer producers apply to riesling as well. For an exemplary California riesling I can highly recommend Trefethen Riesling from Napa, a wine that Eric Asimov of The Pour (New York Times) first brought to my attention earlier this year. This wine is a steal for $16 at my local wine store.

Friday, September 28, 2007

Volatility Index Options Menu Expands: VXN and RVX Options Now Available

When I started this blog, one of the reasons I decided to call it “VIX and More” was that unlike other options indices, it was possible to trade VIX options. Well…I won’t be renaming the blog, but as of yesterday, the CBOE is now trading options on the VXN (NASDAQ-100 Volatility Index) and RVX (Russell 2000 Volatility Index.)

I reported on this development when it was first announced and recently offered up some graphs on comparative performance of the major US volatility indices, but clearly it is time to update the full volatility options tree.

With the new VXN and RVX options, the US volatility indices now stack up as follows:

Additionally, the CBOE has added a new splash page for all five of the volatility indices, which I have pinned to the upper right hand corner of the blog.

The CBOE has also used the occasion of the launch of options on the VXN and RVX to provide some data on these indices that may be of interest to readers. I found it particularly interesting that in terms of activity in the futures (launched July 6, 2007), investors have so far favored the RVX to the VXN by a large margin:

Perhaps related to the above, while a graphic published by the CBOE shows that the VIX has a stronger (negative) correlation to the SPX than do the other volatility indices to their counterparts, it also seems that the relationship between the RVX and the RUT is stronger than that of the VXN and the NDX:

Finally, those interested in implied volatility for the new options can click on the RVX and VXN links to get the appropriate information and graphs from From a historical volatility perspective, these two indices look fairly similar at the moment, but I will keep a close eye on them going forward and report any noteworthy divergences.

Thursday, September 27, 2007

Historical Volatility and One Year Returns

When speaking about options, I have a habit of glossing over historical volatility and focusing on implied volatility. After all, implied volatility is the basis for the VIX calculation and historical volatility, well, for the most part I tend to regard it as a historical artifact that may or may not provide some insight into the current level of IV., however, had some very interesting things to say about historical volatility in an article published last week that bear repeating here. In an article co-authored by Larry Connors (to my knowledge, the only person who has published a book [out of print, unfortunately] dedicated exclusively to the VIX: Trading Connors VIX Reversals), presents their research on 100 day historical volatility patterns and subsequent one year performance for 11,000+ stocks from the period 1995-2007.

Their conclusions may surprise many traders and are certainly worth pondering. In looking at buckets of the 10% and 20% most volatile stocks and comparing these to buckets of the 10% and 20% least volatile stocks, the authors determined that the least volatile stocks were almost twice as likely to be trading higher one year later and, on average, had one year returns more than double (14.7% to 7.3%) their high volatility counterparts.

As an interesting historical footnote, Connors and co-author Cesar Alvarez point out that the lower volatility buckets outperformed the higher volatility group for the entire period studied, with the exception of the middle of 1998 through 1999, during which time the dot com boom phenomenon overrode the tendency for the higher volatility stock to be the laggards. Of course, if you were to remove this period from the study and focus on the remaining 11 years, the superior performance of the lower volatility stocks would be even more impressive than the statistics quoted above.

So the next time you make a lot of money trading those high volatility stocks, make sure you put your profits into a low volatility long-term portfolio…and if the high volatility stocks start to outperform their slow and steady cousins, consider a defensive portfolio. [Bonus points to any reader who comes up with the best ratio chart available on for comparing high volatility stocks to low volatility stocks.]

Wednesday, September 26, 2007

VIX Oversold

At 17.48, the VIX is now 17% below its 10 day SMA and 24% below its 20 day SMA, levels not seen since the end of June 2006. While I am not going to predict that the VIX will jump 43% over the next ten days like it did the last time it was this far below the two SMAs, history suggests that the VIX will start moving up from here and that the broader indices, some of which are approaching previous highs, are due for a selloff.

For the record, the chart below show the VIX with respect to its 10 day simple moving average, with the dotted green lines tracking +10% and -10% from that SMA and the solid green lines indicating the +20% and -20% levels from the 10 day SMA. As a general rule, mean reversion is increasingly likely the farther the VIX strays from the 10 day SMA.

I am inclined to think that the new floor in the VIX for the next month or so will be in the 16-17 range, but that is no more than a guesstimate. How the various sentiment indicators act as we test old highs will tell us a lot about the strength of this decidedly long in the tooth bull. Better not to anticipate, but to prepare for several different contingencies – and keep an eye on the VIX for some clues.

Also, apropos of yesterday's commentary, while the DJIA may be +80 at the moment, I note that many of the recent momentum stocks are in the red: BIDU, GRMN, LVS, BCSI, FWLT, MA, FSLR, AAPL, FCX, PCU, CMI, etc. Keep an eye on this development too.

Tuesday, September 25, 2007

BIDU: Hogs (Eventually) Get Slaughtered

As I write this, BIDU is trading at about 301, meaning that if you got in near the August 16 low, you may be sitting on a 140 point profit.

I was indeed fortunate enough to grab some BIDU on August 16th, though nowhere close to the day’s low of 161. Over the course of the past few weeks I have been taking profits, with less than 10% of my initial position remaining after selling some earlier this morning.

As I was selling some shares, it occurred to me that it might be time to update my watch list of “Overripe High Fliers.” This is a list of ten momentum stocks that I keep a close eye on and expect to provide some clues about speculative activity. These stocks should be strong when the market is rallying and move sharply down when the market turns down. The list currently consists of AAPL, BCSI, BIDU, CROX, DRYS, FSLR, GRMN, LVS, RIMM and VMW.

In keeping with Amazon’s “people who bought X also…” approach, optionsXpress has a tool that tells you what people who traded BIDU were also trading. The results, in the graphic below, could easily be an updated list of those “Overripe High Fliers.” Consider that when BIDU finally makes a sharp turn south (and I expect a -20 day soon), the rest of the stocks on this list will probably be dumped with the same bath water. Contrarians, aim your guns at these targets.

…and don’t count on the nearly vertical rise in BIDU to continue much longer. As a general rule, the steeper the rise, the more spectacular the fall back to earth.

Monday, September 24, 2007

VIX:SDS Ratio a Keeper?

I’ll be the first to admit that I keep track of a boatload of silly VIX charts (hey, it’s better than a house full of cats…) that no person in their right mind should ever bother with, but every now and then one speaks to me in a convincingly enough fashion that I keep going back to it.

So here I am with the VIX:SDS ratio chart again. Alan Greenspan says that the holy grail of market forecasting is a fear vs. euphoria indicator. Frankly, this one is good enough for me – at least for the moment. Given that the SDS ETF has only been around since July 2006, there is little in the way of historical information with which to do some backtesting, but I like how the VIX:SDS ratio has been acting during the recent market action. The ratio may not be a perfect way to decompose the fear and volatility components of the VIX, but it certainly offers a fair share of clues. One way to look at the current reading, for instance, would be to interpret only a small fear premium built into the ratio vis-à-vis the more ‘normal’ sentiment expressed by the 100 day SMA.

If anyone has thoughts on this indicator – pro or con – feel free to use the comments section below to make your opinion heard.

Portfolio A1 Continues Upswing Behind Red Hot Mosaic (MOS)

Thanks to the Fed rate cut, three of Portfolio A1’s five holdings logged gains of 10% or more last week, led by a 12.2% gain in The Mosaic Company (MOS), which now sports an impressive 39.7% return in the five weeks it has been in the portfolio. Also part of last week’s winning trio were DryShips (DRYS) and Navistar (NAVZ). By the time the abacus was put to bed, the gap between the benchmark S&P 500 index and the portfolio had closed to 7.9%, the lowest margin since the mid-August plunge. With a total return of -3.08 since the February 16, 2007 inception, it is beginning to look like the portfolio may soon be back in green.

In the never ending quest for better performance (while keeping a deaf ear to any concerns about high turnover) this week the stock ranking system has jettisoned Sanderson Farms (SFM) in favor of Terex (TEX), an infrastructure play with significant exposure to China. A returnee, Terex was a very strong contributor to the portfolio earlier in the year.

There are no other changes to the portfolio this week.

A snapshot of the portfolio is as follows:

Sunday, September 23, 2007

VWSI Jumps to +6 on Rate Cut

It took 25 trading sessions for the VIX to shed half of the excess baggage it had accumulated by the August 16 intra-day high of 37.50. Thanks to the Fed’s larger than expected rate cut, not only is the VIX looking like a competitor from The Biggest Loser, but Friday also marked the first day since July that the VIX spend the entire day in the teens.

The VIX dropped 5.92 points or 23.8% this week to end the week at 19.00, but consistent with the volatility roller coaster theme, this was only the third largest weekly drop of 2007. The drop was enough to turn the VWSI around, however, pushing that indicator from -1 to +6. The VWSI has only registered an end of week reading of +6 or higher five times since 1998, with four of those five instances seeing a significantly higher VIX over the next few weeks.

I’ll offer up one additional factoid to think about. Consider the current investment climate and consider also that at its present level, the VIX sits a mere 0.07 above its 17+ year lifetime mean. To my thinking at least, the VIX is once again looking like fairly cheap portfolio insurance…

(Note that in the above temperature gauge, the "bullish" and "bearish" labels apply to the VIX, not to the broader markets, which are usually negatively correlated with the VIX.)

Wine pairing:
For a VWSI of +6 I favor a semillon. This often overlooked varietal tag teams with sauvignon blanc to form the white wines of Bordeaux, otherwise known as Graves. The thin skinned semillon grape is particularly susceptible to the Botrytis fungus, which means that semillon is also the primary grape used in the classic dessert wine known as Sauternes.

In the New World, semillon has gained a strong foothold in Australia, where it is frequently blended with chardonnay and sauvignon blanc, but also sold on its own. Last I checked, Peter Lehmann Wines produces four different semillons, with the Barossa Valley one of the most widely distributed in the US. Skipping a little to the east, just this evening I had an excellent 2002 Alpha Domus semillon from New Zealand, but the Kiwis have yet to show the same enthusiasm for semillon that they have for sauvignon blanc. Still, the Alpha Domus effort proves that the potential is there.

It is harder to pick a particular US producer that has built a reputation for semillon, but one to keep an eye on is L'Ecole Nº 41, from the Walla Walla, Washington area.

For more information on semillon, has a good discussion of the varietal, along with a handful of recommended producers in Australia and South Africa.

Saturday, September 22, 2007

Alan Greenspan on Fear and Euphoria

The clip above is from a provocative interview with Jon Stewart of The Daily Show (tip of the hat to Jack Stevison.) Note that at the end of the interview Greenspan has some very compelling things to say about subjects related to fear and, by implication, the VIX. Maybe Alan needs to spend more time on this blog...

"The problem is: periodically we all go a little bit euphoric, until we get to the point where we are effectively assuming with confidence that everything is terrific, there will be no problems, nothing [bad] will ever happen. And then it dawns on us: no!

...I've been dealing with these big mathematical models of forecasting the economy and I'm looking at what's been going on the past few weeks and I say, you know, if I could figure out a way to determine whether or not people are more fearful or changing to euphoric and have a third way to figure out which of the two things are working, I don't need any of this other stuff. I could forecast the economy better than any way I know. The trouble is that we can't figure that out.

...I've been in the forecasting business for 50 years...I'm no better than I ever was and nobody else is. Forecasting 50 years ago is as good or as bad as it is today and the reason is that human nature has never changed. We can't improve ourselves."

Friday, September 21, 2007

Reflections on Investing Ten Years Ago

Yesterday I happened to be rummaging through some old files and came across my 1997 tax return. Fortunately, this had nothing to do with any communications with the IRS, but it got me to thinking about how my investing ‘evolution’ has three distinct long-term phases. Specifically, for the first ten years of my investment life, I dabbled in equities with mixed results at best, in much the same manner as Nicholas Darvas describes his early floundering in How I made $2,000,000 in the Stock Market.

Deciding that the time and effort was not worth the lackluster results, I pushed my savings into mutual funds for the next five years or so, again with fair to middling results. I got a little ornery and started chasing momentum funds like those from PBHG and Van Wagoner, but ultimately concluded that it might be possible for me to try to mimic what they were doing by buying individual stocks on my own.

[As a side note, Gary Pilgrim (PBHG) and Garrett Van Wagoner ended up having more than their share of difficulties, but their approach inspired me to aim higher than beating the S&P 500 by 1.0% point each year.]

To make a long story short(er), the third phase began in 1997 when I decided to go ‘all in’ on a portfolio consisting entirely of internet stocks. While that may not sound all that surprising with the benefit of hindsight, very few investors were buying any internet stocks at the time and frankly there were not that many choices out there. I reasoned (and yes there was some hope involved too) that if most of the technology changes that were being touted at the time came to fruition, it could be a once in a lifetime investment opportunity.

So…I made the type of decision in 1997 that many others would make in 1999 and early 2000. What happened?

In retrospect, I might have done better plowing my money into the Munder NetNet fund (now the Munder Internet fund), but instead, I picked five small and very speculative companies that I thought had a chance to be big home runs if things went my way. The first two companies I started buying up were content plays. If content was going to be king, I wanted to own the king makers. Both of my selections are still alive and kicking: BroadVision (BVSN) had a meteoric rise and then crashed back to earth, Icarus-style; Open Text (OTEX) has led a comparatively uneventful existence, growing slowly and steadily to its current $1.3 billion market cap. My third choice was CyberCash. I expected that someone like PayPal would eventually dominate the electronic payment business with the type of ‘increasing returns to scale’ (described by Brian Arthur, among others) as the industry standard, but alas it was not to be CyberCash, which eventually declared bankruptcy, had its assets sold to VeriSign, with the CyberCash intellectual property eventually ending up at PayPal via an acquisition. In the VoIP communications space, I bought VocalTec, a company that released what I believe was the first internet VoIP program. Now a $16 million also ran (still listed as VOCL, for the record), they even had something called – of all things – the IPhone out back in 1995. Sometimes you can recognize the pioneers by the arrows sticking out of their back... For whatever reason, I felt most confident in the fifth ‘internet stock’ I started buying. Check Point (CHKP) has been a leader in firewall and related security products in the ten years since I first started buying the stock. An Israeli company like VocalTec (for the record, Open Text is Canadian; BVSN was the only Silicon Valley company, as CYCH was headquartered in the Virginia suburbs, just outside of Washington D.C.), Check Point has grown to become a $5.4 billion company, but has always operated in the long shadow of a strong Cisco competitive threat, with this 1998 Check Point press release typical of that battle that has been fought.

So enough of the nostalgia. For those who may be interested, I did hold BVSN all the way to the 2000 top – and then some of the way down. I was out of the other four within a year. In retrospect, CHKP and OTEX turned out to be solid if unspectacular investments; CYCH and VOCL were the two dogs.

I’m not sure exactly what the lesson is here, if any. In 1998 I went on to pick a lot of winners in the internet space – and a lot of dogs. I have always been patient enough to let my winners run, but over the years I have continued to improve my ability to cut my losses quickly and protect my profits for those trades that make a big U-turn. If I had been fortunate enough to have read the likes of When to Sell, written by Justin Mamis in 1977, and It’s When You Sell that Counts, a 1991 classic from Donald Cassidy, I’m sure those early internet years would have been considerably more profitable. In the long run, each individual learning curve has different hurdles and a different timetable. The trick is to get a little smarter every day, even if your portfolio does not always reflect all newly acquired wisdom.

Thursday, September 20, 2007

Party Like It’s 1996?!?

Time for an informal poll again. Raise your hand if you keep track of VIX SMAs going back more than 20 days. What about SMAs going back 1000 days? You may think I’m crazy (sometimes I like to pretend to be crazy just to be a little more provocative, so consider the possibility that I’ve merely intentionally unhinged my brain for awhile,) but if you put any credence in the idea of VIX macro cycles and think it is possible for VIX cycles to last 2-4 years, why not look at the VIX’s long-term moving averages?

When thinking about the current investment environment and the year it most closely resembles, one year I do not recall any reference to is 1996. Look at the chart below and consider that 1996 was not a bad time to initiate an aggressive buy and hold strategy. Do you remember what Yahoo looked like in 1996? No, not the stock (which opened at a split-adjusted 1.05 in April and could be had for 0.64 in July), but the 1996 Yahoo web site.

Continuing the wayback machine theme, coming tomorrow: what I was buying in 1997 and why I was buying it.

Wednesday, September 19, 2007

On the Rarity of a 20% One Day Drop in the VIX

Back in February and March, the wild swings in the VIX inspired me to write extensively about my research into VIX spikes and topics related to volatility extremes. Most of these are spikes higher, as fear is not something that is usually extinguished during the course of a single trading session, just as one slain dragon is not likely to put a village back at ease. After all, what is that the chance that there was only one dragon out there?

There was an instance, however, in which the VIX nearly dropped 20% in one day in March, prompting a retrospective look, at the three previous instances of single day 20% drops in the VIX that I titled “Elast-o-VIX.”

Now that I know enough blog-related HTML to be dangerous, I have updated that earlier graph and added second graph that depicts yesterday’s 23% drop in the VIX in the context of the past week. If the past is prologue, then does it matter if the current VIX drop was not preceded by a VIX runup of similar proportions? That remains to be seen, of course. Past instances notwithstanding, the VWSI currently stands at +4, suggesting that the VIX is more likely to move up from here rather than down in the next week or two.

[With only three previous data points to draw upon, I feel compelled to note that we are a long distance from anything resembling statistical significance, but sometimes historical voyeurism is more interesting than statistical significance, particularly when we are talking about once or twice a decade events.]

Tuesday, September 18, 2007

Rate Cut Projections

Charts courtesy of the Cleveland Fed's web site:

Monday, September 17, 2007

Fireworks Forecast for the Next Few Days

It doesn’t take a lot of courage to predict fireworks in the markets following tomorrow’s Fed announcement, but it is interesting to wonder which stocks will be the biggest movers.

A scan of some of the stocks with the highest implied volatility tells a good part of the story. From the group below comes some obvious choices, such as home builders and lenders. There are also two Chinese companies, including one in the red-hot solar sector, as well as various natural resources plays in gold, oil/gas, and dry bulk shipping. Then, of course, there is the VIX itself.

[The chart above includes only front month at the money options with an IV of 70 or more and a relatively low bar for volume and open interest.]

For the record, the current VIX IV is right in the middle of the 52 week range and has been below 30 day historical volatility for the past month or so.

I have included a Yahoo finance link to all nine high IV stocks (actually eight stocks and the VIX, but who’s counting…) for those who like to play with fire. As I write this, I’ve begun to wonder whether traders are more likely to have been pyromaniacs as children. Hmmm. Are traders more or less prone to having risky hobbies? Lurkers, feel free to weigh in on this one.

DRYS Slows Portfolio A1’s Advance

After rallying impressively over the past three weeks, Portfolio A1 lost momentum last week, due in large part to a 8.5% decline for the week in DryShips (DRYS), after JPMorgan expressed some concern about the drybulk sector.

With four of the five holdings in the red, the portfolio has relied heavily on fertilizer stalwart Mosaic Company (MOS) for capital appreciation, but even with MOS’s 24.4% one month gain, this one-legged portfolio does not have enough forward momentum at the moment to credibly threaten break even soon. Still, with the FOMC about to make a highly anticipated rate cut decision on Tuesday, anything can happen, even a sustainable surge.

There are no changes to the portfolio this week.

A snapshot of the portfolio is as follows:

Sunday, September 16, 2007

Waiting on the Fed; VWSI at -1 Again

By the numbers, last week saw the VIX decline 1.31 or 5% to 24.92, following four days in a row where the VIX opened near the high of the day, then slowly pulled back.

Needless to say, all eyes are on Tuesday at this stage, where the Fed and the VIX will dance on the last day for trading September VIX options and disappointed investors could provide additional confirmation for the current VIX macro cycle.

With the VWSI at -1, held in check largely by the VIX’s relatively low long-term moving averages, I don’t see implied volatility or the VWSI telling us much about what the Fed is going to say, so I’ll be waiting just like everyone else, content to know that it is usually better to try to react than anticipate.

(Note that in the above temperature gauge, the "bullish" and "bearish" labels apply to the VIX, not to the broader markets, which are usually negatively correlated with the VIX.)

Wine pairing:
For a VWSI of -1 I continue to recommend a pinot noir. When I think of California pinot noirs, I immediately think of the Russian River Valley and the nearby small and foggy appelation known as Green Valley. Excellent pinot noir is more the rule than the exception here and four of my favorite producers are Martinelli Winery, Lynmar Winery, Hartford Family Winery, and Dutton-Goldfield Winery.

Further afield, last week, I spoke about three superb pinot noir producers from Anderson Valley: Londer Vineyards, Goldeneye (along with their second label Migration), and Esterlina Vineyards.

For some other suggestions on the pinot noir front, I have another blog with links to a dozen of my favorite producers: Zin and Pinot.

Friday, September 14, 2007

Pre-FOMC Homework

OK, so it’s more like recommended reading than homework, but the links below have given me a fair amount to contemplate in the past few days and they may be a good way to mark time between now and Tuesday at 2:15 p.m. EDT.

Thursday, September 13, 2007

Two Humorous Interludes

Instead of the usual technical analysis mumbo jumbo, I thought I might offer up two humorous tangents for today.

The first comes courtesy of The Onion, as initially brought to my attention by Barry Ritholtz at The Big Picture. Check out a video in which a panel debates the pressing issue of “Are America’s Rich Falling Behind the Super-Rich?

Of course, if you are short the markets and/or one of those perma-bears, you might not find the humor in discussing net worth at the moment. Fortunately for you and your den, Cassandra Does Tokyo has the perfect support group at “Bears Anonymous.”

Wednesday, September 12, 2007

The VIX and the Fed

Since nobody was reading this blog when I first posted about the VIX and FOMC meetings, I thought I might use next week’s highly anticipated FOMC meeting as an excuse to flag some research I published earlier in the year.

Perhaps the most important piece of information on the VIX and the Fed is a study I have placed in the Archive Highlights section of the blog with the title “VIX Price Movement Around FOMC Meetings.” If you follow the link, you can see why the odds favor a substantial volatility contraction on Tuesday, when the results of the meeting are announced, as well as another smaller volatility contraction on Wednesday, after the information has been digested overnight.

While I am on the subject of the Fed and Archive Highlights, I would be remiss in not pointing out what I consider to be the best set of links on the Fed available on the internet, which I have archived in “Fed Links.”

One other blog link is worth flagging here, the rather innocuous sounding “Options Expiration Calendar,” which resides in the VIX and Sentiment Links section in the upper right hand corner. The reason I mention this link is to remind all interested parties that one of the idiosyncrasies of VIX options is that they do not expire on the third Friday of every month, like equity, index and many other options. Instead, 9 months of the year VIX options expire on the Wednesday after the third Friday of the month; 3 months of the year they expire on the Wednesday before the third Friday of the month – right in the middle of options expiration week. As you can see in the calendar linked above, this early VIX options expiration pattern happens at the end of each quarter in March, June, September and December. This means that VIX options expire the day after next week’s big FOMC meeting, with a special opening quotation (more on this another time.) Even more important, the last day for trading these VIX options is the day before they expire. So anyone holding VIX September options will have exactly 1:45 following the Fed’s announcement to close out their positions. Given the high expectations going into the Fed meeting, it will be very interesting to watch the VIX action – as well as the action on the VIX September options.

So while Tuesday will be a particularly busy day for me, remember that you don’t have to play unless the odds are in your favor. When in doubt, get neutral and watch the action for free from the sidelines.

Tuesday, September 11, 2007

ISEE Buy Signal Coming, But Is It Tradeable?

Updating a previous post, it now looks as if the September ISEE buy signal I was anticipating two weeks ago will arrive as soon as Friday.

I’m sure traders across the globe are bursting with excitement, anxiously counting down the minutes until the ISEE tells them to rush headlong into the markets. But really now, is all this faux buildup worth the effort?

Just in time to answer this question, Michael Stokes at has looked at the total put to call ratio as a timing tool in a three part series, published today. In short, MarketSci concludes that while the total put to call ratio has some predictable patterns, translating that knowledge into a winning trading system is non-trivial. In the end, they find that the put to call data can be successfully be used to enhance at least one SPX crossover system.

A couple of comments are in order.

First, when it comes to put to call ratios, I have a preference for the ISEE over all the other ratios because they only count opening options purchases. My second choice would be the CBOE’s equity put to call ratio. Third and fourth would be the total put to call ratio (this sums the equity and index put to call data and was used in the MarketSci study) and the index put to call ratio. The theory is that individual investors are more likely to trade options on individual equities, while large institutions will have disproportionate involvement in index options. (Note that the ISEE has recently started breaking out an equities only ratio, but since this data does not go back very far, I do not yet use it.)

Second, put to call ratios are a great tool. So are volatility indicators like the VIX. It always makes sense to look at these two indicators in concert, as I have talked about vis-a-vis the PCVXO and my own version of this indicator, which I have dubbed the PCEVXO.

Third, I recently reviewed an analysis by the CXO Group of the ISEE and CBOE total put to call ratio. You can follow the links in the previous sentence to read their original analysis, but the bottom line is that they were not enthusiastic about either tool, particularly the total put to call ratio.

Fourth, there are a number of books that offer an excellent treatment of put to call ratios; I will only mention three here. Bernie Schaeffer lays out some of his thinking about put to call ratios in Rick Bensignor’s New Thinking in Technical Analysis; Larry Connors and Connor Sen offer an excellent statistical analysis in How Markets Really Work; and Gary Smith explains his thinking and recommends some models of his own in How I Trade for a Living.

So…read, analyze and test. The answers are out there. And have your finger on the buy button Friday, just in case.

Monday, September 10, 2007

VIX Macro Cycles

On my very first post in this blog, I offered a monthly chart of the VIX from 1993 to January 2007 and identified what I called four VIX macro-periods as follows:

  1. relatively low, flat volatility for 3 years from 1/93 to 1/96
  2. increasing volatility for 1 ¾ years from 1/96 to 9/97
  3. a five year period of extreme volatility from 9/97 to 9/02
  4. the current period of decreasing volatility that began in 4/02 and continues to the present

Now that I have more familiarity with StockCharts, I have updated that chart to reflect the full range of monthly VIX candlesticks from the first official CBOE data in January 1990 to the present. Adding one macro-period to the beginning and end of the original VIX chart, I now have six VIX macro cycles. Ironically, the current period starts just about the same time I started this blog.

A couple of comments on the VIX macro cycle graphic below:

  • This model is a work in progress, even though I like the way it reads at present
  • 2-4 year cycles appear to be the norm (I had earlier favored 3-5 year cycles)
  • The slope of the current macro cycle is unprecedented for the time periods considered
  • The gap between the current monthly candle and the moving averages is also unprecedented

Going forward, I will have a lot more to say about my VIX macro cycle idea, long-term VIX moving averages, and long-term VIX forecasts.

[One quick note on the ‘methodology’ used above. As this chart is more art than science, you could certainly make an argument, as I did the last time around, that the transition from C to D happened in October 1997 instead of October 1998. Frankly, I think either interpretation is correct and does not materially affect any long-term view of the macro cycles.]

Portfolio A1 Continues to Close the Gap on SPX

From the department of small victories comes the news that for the third week in a row Portfolio A1 has taken a small bite out of the gaping performance hole between the portfolio and the benchmark S&P 500. That performance gap, which peaked at 17.5% three weeks ago, has now been sliced to 9.9%.

The Mosaic Company (MOS), a fertilizer producer, has been leading the charge back to respectability, with a 19.3% gain in three weeks. New addition DryShips (DRYS) was up 7.8% in its first week in the portfolio.

Two companies have been dropped from the list of holdings: CNH Global (CNH), despite a 10% return during its holding period; and Western Refining (WNR), which departs with a 7.3% aggregate loss. These companies are replaced by two higher ranking stocks: Sanderson Farms (SFM), a poultry producer; and Navistar International (NAVZ), a returnee to the portfolio after a one month hiatus. Navistar has been in the news lately for its diesel-hybrid technology as well as its armored vehicles.

There are no other changes to the portfolio this week.

A snapshot of the portfolio is as follows:

Sunday, September 9, 2007

VWSI Ends Volatile Week at -1

Another volatile week is in the books, with no signs of volatility coming to an end. While the NASDAQ and VXN took center stage at the volatility circus this week, the VIX managed a weekly gain of 2.85 or 12.2% to end the week at 26.23 – still the third highest end of week close since April 2003.

With back to back 12+% weekly gains in the VIX, the VWSI has slid from +2 to -1 over the past two weeks. These are still largely neutral readings; I do not consider the VWSI to generate tradeable signals unless readings reach at least +3 or -3.

Just for fun, here are a few VIX simple moving averages:

  • 10 days: 23.96
  • 20 days: 25.96
  • 50 days: 21.30
  • 100 days: 17.61
  • 200 days: 14.89
  • 500 days: 13.66
  • 1000 days: 14.28

If you consider that the mean VIX reading for the full 17+ years of VIX data currently stands at 18.92, then any mean reverting activity related to the numbers above is likely to involve a declining VIX. The trick, of course, is to get the time frame right.

(Note that in the above temperature gauge, the "bullish" and "bearish" labels apply to the VIX, not to the broader markets, which are usually negatively correlated with the VIX.)

Wine pairing:
For a VWSI of -1 I recommend a pinot noir, probably my favorite of the lighter red varietals. Perhaps the most overlooked of the locations that produce superb California pinot noir is Anderson Valley, a diagonal finger that extends from northern Sonoma to the Mendocino coast. The climate in Anderson Valley is such that it seems everyone is able to make top-notch pinots, but my three favorite producers are Londer Vineyards, Goldeneye (I believe this winery is still on the selling block; be sure to try their second label, Migration, as well), and Esterlina Vineyards.

For some other suggestions on the pinot noir front, I have another blog with links to a dozen of my favorite producers: Zin and Pinot. The content on that blog has been intermittent as of late, but as the markets get back toward some sort of ‘normal,’ I hope to remedy this.

Friday, September 7, 2007

Volatility Index Comparison

I last put up a chart of the five US equity volatility indices in mid-March, following the February 27th VIX spike. Now that we also have about three weeks following the VIX spike, I thought I might put up a similar chart of the volatility indices for the recent market action.

The recent volatility spike (top chart) shows VXO once again leading the charge upward, with VXN the laggard -- just as was the case in March. Interestingly, during the secondary surge in volatility over the past two weeks or so, the VXN has been the most sensitive.

With VXN and RVX options just around the corner, the relative movements of these volatility indices are becoming increasingly more interesting (and important) to watch.

VXN and RVX Options Coming September 27th

The CBOE announced yesterday that it plans to begin trading options on the VXN (NASDAQ-100 Volatility Index) and the RVX (Russell 2000 Volatility Index) as of September 27, 2007.

This announcement comes just two months after the CBOE began trading futures in the VXN and RVX.

While VIX and More will not quite provide tick by tick coverage of VXN and RVX options, it is a fairly safe bet that I will have more to say about them than just about anyone else.

Thursday, September 6, 2007

Pre-Employment Report Links

The more volatility we have, the less likely I am to set aside some time to collect and publish some of my favorite recent links, hence the lack of links here in the past month or so. I don’t want this informational/archival aspect of the blog to atrophy during the period when it may have the highest archival value, so I offer up the following links (including several voices new to this blog) that captured my attention during the last couple of days:

Wednesday, September 5, 2007

VIX Futures and Recent Market Action

Raise you hand if you have been following VIX futures during the all the volatility we have had over the past month or so. Hmmm. About what I thought. At least you are a relatively honest bunch. (Anyone wanting to dip a toe into the VIX futures water might want to check out my VIX Futures Starter Kit.)

With the chart below as a backdrop, consider that the February 27th VIX spike – and all the subsequent volatility – had virtually no impact on expectations of where the VIX would be in February 2008.

Fast forward five months to the increased volatility at the end of July and we see that the VIX February 2008 futures rose in advance of the cash VIX spike and peaked before the cash VIX top of 37.50 (intra-day) on August 16 (reflected here with the 30.83 close.) While the February futures settlement date is still 5 ½ months out, the VIX futures have persisted in the 20s and currently sit at 21.48, not too far at all from the 22.65 peak on August 17th.

Going forward, think about the VIX futures six months out as a fair proxy for what market participants think about structural weakness in the economy and in our financial institutions and the difference between the cash VIX and these futures as a gauge of fear and panic in the markets. Also consider that the best opportunities for trading the VIX are likely to be when there is the widest gap between how the markets are pricing the cash and futures VIX.

Tuesday, September 4, 2007

The Emerging Markets Engine

As I write this, the EEM is about 6% off of its 52 week high, but even this number dramatically understates the staying power of this emerging markets ETF.

A better way to think about the strength of the EEM is to look at its performance relative to that of the EFA, a capitalization-weighted ETF that necessarily tilts strongly in the direction of the most developed countries in Europe, Australasia and the Far East, as the fund’s holdings confirm.

Looking at a ratio chart of the EEM to the EFA, you can see that over the course of the past 4 ½ years, returns in emerging markets have consistently outstripped those of the EFA, save for two brief periods in the summer of 2004 and the summer of 2006. What I find particularly interesting is that the normally skittish emerging markets barely flinched (note the Williams %R) during the corrections that hit the SPX in February and July of this year. Not only were the dips in emerging markets brief, but the recovery in these markets was much stronger and faster than it was in the SPX or the EFA, as anyone who has watched the Chinese markets and the FXI ETF in particular can attest to.

Other ratios of speculative activity, such as the capitalization ratios of the RUT:OEX or RUT:SPX, reflect some of the battle scars of the last few months. Speculative activity in emerging markets, however, continues to show healthy investment in that sector. Whether speculation in emerging markets is in fact too healthy may become an issue in the coming year, but for now I am content to conclude that a powerful emerging markets engine is a positive signal for the global economy.

Portfolio A1 Slowly Closing Gap on SPX

For the second week in a row, Portfolio A1 has taken a small bite out of the gaping performance hole between the portfolio and the benchmark S&P 500. What was a 17.5% gap two weeks ago is now down to a slightly more manageable 11%.

The two agriculture-based holdings, Mosaic (MOS) and CNH Global (CNH), continue to lead the resurgence, up 16.8% and 9.5% respectively in the two weeks they have been in the portfolio.

Speaking of bright lights, I was more than a little surprised to see the portfolio drop PepsiAmerican (PAS) this week. The Minneapolis-based bottler was added to the portfolio three weeks ago on the strength of very solid fundamental numbers across the board and has been very strong technically, making a new 52 week high on Friday (and again this morning)…but apparently an 8.8% gain in three weeks is not good enough to keep it from yielding its slot in the portfolio to shipping juggernaut DryShips (DRYS), a company that is up almost 500% in the past year and yet still manages to sport a P/E under 13.

From my vantage point, it appears that adding DRYS is an implicit endorsement of continued global economic growth and a move away from a more conservative food and beverage play. Even though the mechanical system behind Portfolio A1 doesn’t use this type of market logic in its decision-making, this does not stop me from putting my interpretive spin on what comes out of the black box.

There are no other changes to the portfolio this week.

A snapshot of the portfolio is as follows:

Monday, September 3, 2007

All Quiet on the Volatility Front; VWSI at Zero

It has been six weeks since the VWSI closed at an even zero – the point at which theoretically I should have no opinion about the direction of the VIX over the next week or two. Coming off a week where the VIX traded up 12.8% to 23.38, I am hard pressed to pick the next direction for the VIX, particularly since it has ranged all the way from 15.36 to 37.50 during those turbulent six weeks.

One data point in particular stuck me last week, a report from Bloomberg (with a hat tip to Toro’s Running of the Bulls) that insider buying at financial institutions hit a 12 year high in August.

So while ‘quiet’ on the volatility front is a relative thing, it does seem as if a 30-something VIX gets farther and farther away with each passing week, particularly given the lack of gory headlines involving i-banks, banks, and hedge funds. Unless the next installment of fear arrives quickly, it will almost certainly lack the visceral punch and bloodletting potential that similar news would have had a week or two ago.

Bottom line: don’t be surprised if we see the VIX in the teens in another week or two.

(Note that in the above temperature gauge, the "bullish" and "bearish" labels apply to the VIX, not to the broader markets, which are usually negatively correlated with the VIX.)

Wine pairing: For an inexpensive Rhone blend, I continue to recommend: Oakley Five Reds; Robert Hall’s Rhone de Robles and Tablas Creek’s Cote de Tablas Blanc; Wrongo Dongo, the contrarian favorite from Spain; and The Stump Jump (I prefer the white over the red) from Australia. If you are looking for additional ideas, I encourage you check out the Rhone Rangers.

Book pairing: This time only, I feel compelled to add the obvious literary pairing: if you haven’t read Erich Maria Remarque’s timeless classic, you are truly missing out.

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