Friday, November 30, 2007

New Blog/Site Recommendation: Index Indicators

It is rare that I go out of my way to devote an entire post to a particular blog or web site, but in the case of this type of attention seems warranted, even though the web site is only in the second week of its life.

First things first, a tip of the hat to Headline Charts, which is already incorporating some Index Indicators charts into the site's weekly Friday Market Sentiment report, which should be a mandatory stop for brushing up on the latest in various market sentiment surveys and related data.

Of particular interest to VIX and More readers will likely be the Index Indicators market commentary blog and the wide variety of charts they provide for breadth indicators, put to call ratio indicators and volatility indicators.

Charts are of the end of day variety, range from three months to three years, and include the following information:
  • Breadth indicators – % of stocks above their 5, 10, 20, 50 and 200 day SMAs; also % of stocks whose 5, 10, 14, and 21 day RSIs are above 70 or below 30

  • Put to call ratio indicators – the 5, 10 and 20 day SMAs for the CBOE equity, index and total put to call ratios

  • Volatility indicators – the 5, 10, 20, 50 and 200 day SMAs for the VIX, VXO and VXN, plus the current level of each of these indices relative to these SMAs (see below for one such chart)
In sum, this new site is an excellent source for data and charts on three subjects that are central to my trading and to the blog as well. For this reason, I have also added to the “VIX & Sentiment Links” in the upper right hand section of the blog.

Thursday, November 29, 2007

The Promethian Trader

I may be projecting a little here, but I suspect that most who are new to trading generally approach the subject as a problem largely consisting of how to build and implement a consistently profitable trading system.

While there are several excellent blogs that deal largely with the trader’s personality (most notably Brett Steenbarger’s TraderFeed and Corey Rosenblum’s Afraid to Trade), I have yet to say much of anything on this subject, even though I am strongly of the opinion that eventually all traders will realize psychology is the most important part of trading, even those who are using mechanical systems. In Trade Your Way to Financial Freedom, noted author and trading consultant (and occasional blogger too) Van Tharp puts it this way:

“When I’ve had discussions about what’s important to trading, three areas typically come up: psychology, money management (i.e., position sizing), and system development. Most people emphasize system development and de-emphasize the other two topics. More sophisticated people suggest that all three aspects are important, but that psychology is the most important (about 60%), position sizing is the next most important (about 30%), and system development is the least important (about 10%).”

With this in mind, I was most interested to recently discover that Tharp had published an eight part series outlining some of his thoughts on personality types and trading. For those who may still be skeptical of the importance of psychology, before dismissing the articles, be sure to jump down to Part Eight, where Tharp talks about the Promethian Temperament. Tharp tosses out two statistics that I found particularly interesting:

  1. The Promethian Temperament (xNTx in Myers-Briggs speak) occurs in his sample trader population at a rate more than twenty times that of the general population; and
  2. “Among our NT traders, about 10% show outstanding trading records—a higher percentage than any of the other temperaments.”

Tharp goes on to explain that despite the fact that NT traders are handicapped by a strong desire to predict, control and explain the markets, they overcome this and are successful as a result of their insistence on acquiring more self-knowledge, continuously improving their craft, and applying as much science as possible to potential trading approaches.

If you are an NT, as I am, you probably know all of this already, but you might want to read the article closely to look for the shortcomings that NTs are prone to. If you are not an NT trader, consider how your Myers-Briggs personality type my help to accelerate and simplify the process of identifying your potential strengths and weaknesses as a trader.

Wednesday, November 28, 2007

McClellan Summation Index Looking Bullish

A lot has been written about weakness in market breadth in the past week or so. With storm clouds looming over advances and declines, new highs and new lows, volume, etc., one might conclude that the breadth story is uniformly negative. Part of that interpretation depends upon whether you look at the ‘bad news’ in market breadth as confirmation of the breakdown in the broad market indices or whether you consider market breadth extremes to be contrarian indicators – at least in the short-term.

I fall into the contrarian indicator camp, but tend to focus on the intermediate term when it comes to highs and lows. Short-termers may be partial to the McClellan Oscillator; I am more interested in the McClellan Summation Index.

When I last posted about the McClellan Summation Index, it was October 25th and I was concerned about two technical aspects of the index that I interpreted as bearish. It certainly has been a bearish month since then, but now the index suggests that we are coming out of an extreme oversold condition that should provide a bullish foundation for at least the next few weeks…so I’m back on the bull side of the fence for now.

Tuesday, November 27, 2007

Not a Lot of Fear or Volatility Lately

Given all the gloom and doom headlines across the mainstream media and blogging world (the lines are already blurring, it seems…) I am a bit surprised to see how little journalistic panic (embellishment?) has translated into market panic.

Starting with the graphic to the left, which depicts the frequency that the term “VIX” has appeared in blog posts with a certain minimum Technorati authority level over the past 180 days (see original tool), it almost appears as if the VIX is an idea whose time has come and gone. Lately, the talk is all about subprime, CDOs, SIVs, with interest rate spreads as the scorecard de jour. The markets may be down 10%, but with the VIX at 26 and change as I type this, the VIX is not part of the story.

In my ongoing effort to attempt to differentiate between fear and volatility, I turn to the VIX:SDS ratio at moments like these to see how fear has waxed and waned while the markets have fallen rather dramatically. The one year chart of this ratio is below. Previous incarnations of the VIX:SDS ratio chart have all been of the 6 month variety, but I think it is important to look at the current market environment and be able to compare it to the February-March and July-August VIX spikes (the SDS inverse ETF only launched on 6/13/06, so it is not possible to capture the ratio during VIX spike from 5/12/06 to 6/13/06.)

There are many ways to think about this chart (keeping in mind, of course, that it compares an oscillating number with a beta of about -4.2 to a trending number with a target beta of -2.0), but what I keep coming back to is the distance between the current reading or 10 day SMA and the longer-term 100 day SMA. In some respects, this isolates the magnitude of the fear component of the VIX and in the chart below, it underscores how little fear there has been relative to the recent drop in the SPX, especially when compared to similar values in February-March and July-August. I am not sure exactly how to interpret this, but I suspect that either the market will recover to a level that is commensurate with the fear, or perhaps we will see a significant VIX spike well into the 30s that will likely signal a near-term bottom. And despite what you read elsewhere, not all market bottoms require a high volume capitulation session, with an accompanying VIX spike.

Monday, November 26, 2007

Smart Money and the VIX

Bernie Schaeffer’s “Monday Morning Outlook” is generally an excellent perspective for any trader to contemplate going into the trading week. This week’s commentary is one of the better ones, as Schaeffer looks at a variety of data points to consider whether or not the markets may be putting in a bottom.

One of the themes that Schaeffer takes up is a sense of concern starting to overtake the recent investor complacency. Schaeffer cites the VIX as an example of continuing complacency in his remarks and in so doing goes on to make a potentially more interesting claim that he and his colleagues believe the VIX action represents the maneuverings of the smart money:

“One dissenter to this growing crack in the complacent armor was the VIX, which was little changed even while the market moved defiantly into losing territory. In fact, the supposed ‘fear barometer’ has shown little signs of alarm for a few weeks now, preferring instead to shuffle sideways. It has yet to make a significant move above the 30 level or come within sniffing distance of its mid-August peak.

However, the VIX action presents some very interesting possibilities. Its continued inability to move below the 32-week trendline is bearish, as we've pointed out before. But I wonder whether the fact that the November spike has fallen short of the August spike might actually be bullish in its implications, in the sense of a ‘non-confirmation’ of the pullback, rather than the conventional view that this is a bearish indicator of complacency. This interpretation would only make sense if you felt the VIX represented smart money, an evolving conclusion that we at Schaeffer's have reached over the course of this year [emphasis added]. Note that you could consider the VIX spike in the first quarter to be a non-confirmation relative to the spike in the second quarter of 2006, as it fell shy of the 2006 peak. The spike to higher VIX highs in August then ‘confirms’ the bearish trend, and by that reasoning (assuming the VIX has, in fact, peaked) the current spike is another non-confirmation with bullish implications.”

Setting aside the caution-complacency issue for the moment, I find it interesting that Schaeffer believes the VIX is the footprints of the smart money. I am slowly coming to the same conclusion myself and will attempt to address this issue a little more scientifically in this space in the future.

Sunday, November 25, 2007

Portfolio A1 Dragged Down By Perini (PCR)

With a little over a month to go in the trading year, Portfolio A1’s 1.5% gain provides only a slim margin over the 1.0% loss in the benchmark S&P 500 index. That margin shrank substantially last week, on the heels of continued weakness in Perini (PCR).

When stories start circulating with headlines like Stop the Blank Checks to Iraq Contractors, it is no surprise to see the stocks Perini and other top contractors in Iraq and Afghanistan suffer in the wake of a swirl of bad publicity. After losing 11.5% in two weeks, Perini (PCR) is now down 32% from its July high and is being dropped from the portfolio as a result.

Replacing Perini in the portfolio is the first stock to be bought on three separate instances: DryShips (DRYS). Portfolio A1 rode DryShips up earlier in the year and had less success with an early October buy. If the global commodity boom continues, this may look in retrospect to be an excellent buy on weakness; on the other hand, if the anxieties and slowing economic growth in the US start to be felt around the globe, then it may be a long time before DryShips’ stock approaches the October highs once again.

With the addition of DryShips, the portfolio looks to be positioned aggressively for the final five weeks of the year. If it turns out that we are in a bear market, that 2.5% cushion over the SPX will likely be long gone by the end of December.

There are no other changes to the portfolio this week.

A snapshot of the portfolio is as follows:

VWSI Holds at Zero in Advance of Black Friday Data

It was a quiet week in Lake VIXbegone. Very quiet. So quiet, in fact, that the VWSI remained stuck on a zero reading for the second week in a row and the VIX gained only 0.47 points or 1.8%, the fourth lowest weekly change all year.

As is my new custom, I look to Barry Ritholtz at The Big Picture to sum up the week that was and the week that will be:

Consumers were apparently keen on snapping up bargains on Black Friday, where sales were up 8.3% over last year and followed through on Saturday, with sales up 5.4% versus the previous post-Thanksgiving Saturday. The combined Friday-Saturday statistics show a 7.2% increase in sales over 2006, with a 4.8% increase in traffic more than making up for a 3.5% decline in purchases per person.

Whether the surprising strength in consumer spending will take some of the momentum away from the bears remains to be seen, but my personal bias is slightly bullish going into the week, despite the weakness in a number of technical indicators.

(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 zero, I have heretofore been recommending a variety of inexpensive blends. Just this week I enjoyed the 2005 Trentadue Old Patch Red. This berry explosion is an unusual blend of 70% zinfandel, 20% petite sirah, 5.5% carignane and 4.5% syrah. Surprisingly, the petite sirah comes through as dominant, with the zinfandel playing a rare secondary role, with the exception of what I thought was a touch of residual sugar in the finish. This is a fun wine to drink and at $12 at my local wine store, worth seeking out.

Previous recommendations for a VWSI of zero have included Brassfield Serenity, as well as a wide variety of Rhone blends.

Friday, November 23, 2007

A Dozen Things My Trading Accounts Are Thankful For This Year

I am a strong proponent of taking stock of what is working and what is not working on a regular basis.

That being said, if my trading accounts could speak, these are some things they would be thankful for so far in 2007:

  1. More active use of trailing stops (probably the #1 reason for increased trading success in the past few years)
  2. Increased use of the VIX (and VWSI) to aid in timing the market
  3. Emphasis on put to call ratios (especially the ISEE) to evaluate market sentiment
  4. Lack of hesitation in initiating short selling positions (the end of a long bias approach)
  5. Blogging – and all the cross-pollination of ideas that it has engendered
  6. ETFs – to diversify, go short, apply leverage, etc.
  7. More time stops (including hybrid price/time stops such as a Parabolic SAR)
  8. Better strategies for taking partial profits in options positions
  9. Following the China trend, whichever direction it takes me
  10. Iron condors and other strategies to capture premium associated with high volatility and/or non-trending securities
  11. Numerous enhancements to a detailed and continuously evolving spreadsheet I use to track and analyze all my trades
  12. Standardization on a single momentum indicator for my charts: Williams %R

Wednesday, November 21, 2007

OHFdex Update

Since several readers expressed some interest – or at least some amusement – in the OHFdex (Overripe High Fliers Index) I unveiled back on October 12th, I though it might be interesting to see how these high fliers have fared during the recent market turmoil.

Given that most major indices peaked at the end of October, I did not expect the changes from October 12 to November 20 to be particularly dramatic, but as can be seen below, the devastation over the past 5 ½ weeks has been widespread and substantial, even though it is only a small portion of most of the peak to trough losses over the past three weeks.

The companies that have fared the best during the period in question have done so partly with a stronger post-October 12 runup, but also by doing a better job of weathering the current downturn. These are the tech stalwarts, AAPL and RIMM (GOOG was also up 11 points during this span), as well as the two Chinese tech plays, BIDU and CHL.

I have been short five stocks on this list at one time or another during the past three weeks: AAPL; BIDU; GRMN; DRYS; and CROX. I suspect that most of the easy money on the short side has already been made, but if the NDX fails to hold 2000 and if the NASDAQ composite cannot stay above the 200 day SMA (currently 2584), I’ll flip from neutral to bearish and look to this list to find where the momentum money is most nervous.

Tuesday, November 20, 2007

Three Noteworthy Posts from Afar

In the blogosphere it’s hard to really say what ‘afar’ is – or even if there is such a thing – but I wanted to use this space to highlight three VIX-related posts that have recently caught my attention.

Earlier this morning, Macro Man (whose intellectual domain spans well beyond the macro) was ruminating on what a convergence of thinking about the VIX, the credit markets, and the US consumer might mean in terms of the future direction of the markets in a post aptly titled Fear and Greed. For the record, I have commented on the correlation between the SPX and the VIX on a number of occasions and have pointed out that a high positive correlation is more likely to foretell a bearish move than a high negative correlation.

Adam at Daily Options Report (as much as he posts, when does he have time to trade?) anticipated some of this yesterday in VIX Going Forward, in which he discusses the Holiday Effect and the tendency of traders to lower bids in order to better match the short trading week to the seven day calendar week used to price options. His Holiday Effect forecast: “volatility numbers on the board this week may be misleadingly low.” Bingo!

Getting a little farther afield, over the weekend, Brett Steenbarger at TraderFeed posted some very interesting research and analysis in Herding Behavior in the Stock Market: A Look at Volume Concentration. Frankly, this may be the most interesting stock market post I have read all year; rather than attempt to summarize his thinking, I am going to recommend that you click over and read his post in the original, as well as a related subsequent post, Herding Sentiment in the Stock Market and Prospective Index Returns. In between turkey (ham?) sandwiches, I will certainly be thinking about market sentiment, volatility, and herding over the next few days.

Happy holidays to all.

Monday, November 19, 2007

Very Low ISEE on Friday

The ISEE’s close of 68 on Friday was the seventh lowest end of day reading in the index during the five years for which data is available.

As a rule, one day’s worth of data in the ISEE means very little in the long run, while a week or two of extreme readings is generally needed to provide high probability trading setups. With the ISEE currently at 107 as I type this, today is on schedule to be the ninth trading day in a row in which the ISEE has closed at least 15% below its lifetime mean of 151. In fact, looking back to the correction of the summer of 2006, the ISEE has consistently been bullish since that time period.

With the DJIA down another 150 points today, the ISEE data may not be much consolation for longs, but for those who put stock in market sentiment, it looks like the current downturn is more likely to be a short-term correction than an enduring bear market.

MOS and PCR Slow Down Portfolio A1

The run in Mosaic (MOS) certainly was not going to continue indefinitely, but last week’s correction was rather dramatic, as the MOS chart shows. Compounding an already difficult week, Perini (PCR), whose addition to the portfolio caused me to raise an eyebrow at last week, did nothing to assuage my concerns, losing 7.5% in the first week.

The result is that Portfolio A1 now sits with a gain of 5.7% since the February 16, 2007 inception, still comfortably ahead of the 0.2% gain in the benchmark S&P 500 index. As is evident from the bottom two graphics, this enhanced performance has come with considerably more risk than the SPX in the form of a much higher variability of returns. The next iteration of this portfolio (to be launched at the beginning of 2008), will aim to minimize risk somewhat more than the current portfolio, while continuing to seek out stocks like Mosaic that can supercharge returns. The ride will no doubt be just as interesting – and hopefully more profitable and instructive.

There are no changes to the portfolio this week.

A snapshot of the portfolio is as follows:

Sunday, November 18, 2007

VWSI Swings From -10 to Zero in Wild Week

When you are playing the VIX mean reversion game, it doesn’t get any better than last week.

We entered the week with the VIX Weekly Sentiment Indicator (VWSI) at an unusually low -9 reading, but by the time the bull carnage had been tallied on Monday evening, the VWSI was maxed out at -10 and the VXN was looking even more ‘overbought’ than the VIX. These extreme readings triggered a rare market call on my part, which I titled a VXN Reversal Signal, but which also applied to the VIX. On Tuesday, the markets responded on cue, with the NASDAQ composite rallying 89.52 points in an impressive show of strength…and pushing the VWSI all the way back to zero.

Given the fireworks on Monday, the rest of the week was relatively uneventful, with the major market indicies largely meandering and the VIX ending the week at 25.49, down 3.01 (10.6%) from the previous week. In a nutshell, Waldo was nowhere to be found.

As is my new custom, I look to Barry Ritholtz at The Big Picture to sum up the week that was and the week that will be:
The VWSI has no bias going into the shortened week (3 ½ trading days, with the half day on Friday) and I find myself in the unusual position of sitting mostly in cash while I look for the currents to tell this jellyfish where to go next.

(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 zero, I have heretofore been recommending a variety of inexpensive Rhone blends. The time has come to loosen the reins a bit and broaden the category to include everyday white and red blends from all varietals and regions, as long as they are reasonably priced. With this expanded criteria, I am please to recommend an usual blend of sauvignon blanc, pinot grigio, gewurztraminer, and semillon that goes into the Brassfield Serenity. This is an $11 white blend that is not just a fascinating change of pace, but an excellent food accompaniment and ultimately a wine that is quite impressive as a solo act as well. Finally, if you want to stump your favorite wine snob in a blind tasting, this is almost guaranteed to do the trick…

Friday, November 16, 2007

Nassim Nicholas Taleb on Charlie Rose

I highly recommend that every investor read Nassim Nicholas Taleb’s two books on uncertainty, luck, risk, and revisionist history: Fooled By Randomness: The Hidden Role of Chance in Life and in the Markets; and The Black Swan: The Impact of the Highly Improbable.

For those who are interested in a video Cliffs Notes version of Taleb’s thinking, Charlie Rose has a 15 minute interview with Taleb that aired back in August (hat tip to Eddy Elfenbein at Crossing Wall Street.)

Thursday, November 15, 2007

The Other Bubble

I have visited 47 states (all except North Dakota, Arkansas and Oklahoma) and seen a lot more of this country than most will ever see, so when I look at the various foreclosure and subprime maps that have been making the rounds lately, it is easy for me to picture many of these places and the residents I have met there along the way.

On the other hand, I live just north of San Francisco in Marin County, which in many ways, is like living in a completely different kind of bubble in terms of real estate values, disposable income, attitudes, politics, etc. When it comes to real estate in the area, starter homes in the $3 million range are not uncommon. For some additional context, a couple of years ago my wife and I looked at a local $8.5 million house that lacked a private master bedroom and was in need of a fair amount in the way of repairs.

In spite of the projections by the Marin Real Estate Bubble blog, local real estate has been surprisingly resilient. The Marin Real Estate Report tracks a variety of real estate data and is the source of the graphic below, which shows that for the past seven years, real estate has climbed fairly steadily, at least when adjusted for seasonal trends. The story is different in other parts of California, as comparable San Diego data show, but for now at least, the full extent of the Marin bubble seems to be intact.

Wednesday, November 14, 2007

Catching Up On Reader Mail

Thanks to all who have commented and e-mailed me in the ten months the blog has been up and running. Readers have been a great source of ideas for my research and have helped to sharpen my thinking about the markets and ultimately my ability to trade them successfully.

Some interesting comments and mail have been coming over the transom lately and I thought I’d address a couple of these in public.

There have been a couple of questions about VIX futures. I have not traded them to date, but it is something that I will definitely play with in the coming year. Even though I do not trade them, I certainly watch VIX futures closely, particularly the spread between the front month and the six month futures. Anyone interested in getting a sense of my emerging thinking in this area should check out posts with a VIX futures label. Also, note that the fifth and sixth links from the top in the “VIX and Sentiment Links” in the upper right hand corner of the blog both concern VIX futures.

Straying only a little from VIX futures, someone mentioned VXV, a new product from the CBOE which was launched on Monday and calculates the three month implied volatility in the SPX. The VXV may provide an interesting contrast to the one month IV in the SPX that is reflected in the VIX. I will certainly be taking a close look at the VXV and post my thoughts about it in short order.

Another reader asked if there is any way to invest in the cash or spot VIX directly. Unfortunately, the answer is no, though it is possible that a VIX ETF may be on the horizon. Some technical aspects of creating a VIX ETF (or ETN) are fairly daunting, but given the demand for volatility products, I would expect that it is only a matter of time before we see the launch of at least one volatility ETF.

Finally, one question concerned whether it is possible to replicate the spot VIX by buying a basket of delta-hedged SPX options to essentially re-create how the VIX is calculated. This is certainly possible, if a little complicated. A simpler approach would be to use SPX or SPY options, where you could go long or short volatility with straddles and strangles. If you prefer to hedge your short volatility positions, as I do, you might want to stick to butterflies and condors.

Tuesday, November 13, 2007

Quote for the Day, From Stuart Walton

"My philosophy is to float like a jellyfish and let the market push me where it wants to go."
- Stuart Walton, as quoted in Stock Market Wizards by Jack Schwager

VXN Reversal Signal

The attached chart shows the VXN (volatility index for the NASDAQ-100 or NDX) over the past five years, with a 10 day simple moving average, flanked by dotted lines representing 20% above and below the 10 day SMA.

Anybody who has been paying attention knows that the last several days have been highly unusual. As the chart shows, the VXN, which rarely closes outside of those 20% bands, is currently 38.2% above the 10 day SMA. This is about as extreme as it gets for volatility outliers and suggests a high probability of a sharp reversion to the mean in the VXN, coincident with a bounce back in the NDX.

For the record, the same market bottom signal is coming from the VIX and SPX, but without the extreme reading that is characterized by the VXN and NDX. By contrast, the signal from the RXV and RUT is substantially weaker and only marginally tradeable.

Volatility signals with this level of confidence are extremely rare, so if you are looking for an excuse to get long in a big way for the short term, or to trade VIX along the lines recently suggested by Brian Overby, today is an excellent opportunity to try to time the markets.

Monday, November 12, 2007

NASDAQ Chart with Hourly Bars

On Friday I posted a weekly chart of the NASDAQ going back six years. Today I am swapping the wide angle lens for a telephoto one and focusing on hourly bars for the past month. I am emphasizing the NASDAQ Composite (and the NDX) because that is where a good deal of the speculative activity has been as of late and where the correction was most severe last week.

The graph below shows four semi-arbitrary simple moving averages for the NASDAQ Composite Index: 13 bars; 20 bars (the faint dotted gray line in the middle of the Bollinger Bands); 30 bars (the same as the Williams %R time frame); and 100 bars. All this spans roughly a period of 1 ½ days to about 3 weeks. With the aforementioned Bollinger Bands and Williams %R data, as well as the Fibonacci retracement lines, there are many ways to keep score. As much as anything, however, I will be looking at the intensity and duration of the bull rallies off of the bottom. Given that many indicators point to the current situation as significantly oversold, the absence of a compelling bull rally may provide as much information as what is actually happening. In other words, a draw should favor the bears.

Finally, I still haven’t seen much in the way of fear yet…

Portfolio A1 Increases Lead Over SPX as Markets Drop

After the disastrous mid-August performance, it was heartening to see Portfolio A1 outperform the benchmark S&P 500 index during last week’s market turbulence. While the margin of outperformance was small, this now means that the portfolio is up 9.6% since the February 16, 2007 inception – a period in which the SPX is down 0.1%.

Some of the portfolio’s individual holdings did not fare particularly well during the week, with the result that the stock ranking system has elected to drop DryShips (DRYS) and StatoilHydro (STO). These stocks are being replaced by China Petroleum & Chemical Corp., more commonly known as Sinopec (SNP), as well as Perini (PCR), the large Boston-based construction company. In spite of the very strong year it has had, I am not sure I would be chasing Perini at this point, but, this being a mechanical portfolio, all I can do is raise an eyebrow and be prepared to eat some crow.

There are no other changes to the portfolio this week.

A snapshot of the portfolio is as follows:

Sunday, November 11, 2007

VWSI Hits -9 as VIX Spikes

In a week where technology stocks were hit harder than financials for the first time in a long time, the VXN rose 30.1% while the VIX rose 23.9% or 5.49 points. Coming on the heels of last week’s 17.6% jump in the VIX, this marks only the third time this decade that the VIX has risen 15% or more in two consecutive weeks, with the two previous instances being two weeks in the middle of May 2006 and the two weeks spanning 9/11.

Even with the VIX printing a rare -9 reading (the third -9 in four months, but only the fifth in the past six years) and the NASDAQ registering the biggest weekly drop in five years, the selloff had a relatively orderly feel to it – at least so far. The fact that the VIX is still ten points below its mid-August high suggests a lack of panic, as does the below average fearogram readings for the SPX:VIX ratio on both Thursday and Friday.

In addition to the extra spice of options expiration, next week’s government data includes a hearty broth of October retail sales data (Wednesday), October consumer prices (Thursday), and October’s industrial production and capacity utilization figures. Earnings season continues, with a healthy does of retail and technology earnings on tap as well.

For a comprehensive look back on last week and a glance at what the coming week may have to offer, I recommend the following links from Barry Ritholtz at The Big Picture:

While the -9 VWSI reading suggests a likely bounce in the coming week, my Where’s Waldo analysis tells me that long red candles in the NASDAQ rarely trigger bounces in the following week. Given that history, the relative lack of fear in the SPX:VIX ratio, the failure of the ISEE to drop below 100 last week, and several other factors, I enter the week by carrying over my bearish bias. I will be watching closely to see what sort of enthusiasm the bulls put into efforts to establish a bottom and threaten yet another quick retracement. This time around I expect it to be at least as difficult as it was in the summer of 2006 for the bulls to push the markets back to new highs, but…this selloff is still early.

(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 -9, I continue to recommend carmenere as an ideal pairing. The last time around, I sugested a Concha y Toro 2003 Terrunyo Carmenere, some favorite carmeneres listed at Cellar Tracker, and an American effort at Dover Canyon. For ideas about varietals I do not have a lot of experience with, I often check out what is selling at one of San Francisco’s best wine stores, K&L Wine Merchants. A quick search on their site yields a good number of carmenere blends, as well as several selections where carmenere is the dominant varietal.

Friday, November 9, 2007

Where’s Waldo?

The markets have not been a lot of fun and games for the past couple of days, so I thought this might be a good time to play ‘Where’s Waldo?’

For the sake of argument, instead of that trademark red and white sweater and cap that often gives him away, imagine that Waldo is a long red candlestick followed by anything that looks like a strong bounce back week immediately thereafter. Can you find a Waldo that looks like this? While there are many long red candlesticks, I can’t find one Waldo – at least looking at the NASDAQ weekly chart going back six years. Don’t forget that almost the entire period covered in this chart is a raging bull market, so the bias should be bullish and there should be a bunch of Waldos.

How many longs will be brave enough to hold over the weekend? My sense of the current market is that the ugliness continues at least into the first half of Monday’s session, at which point the bulls will have their first chance to show what sort of firepower they still have left.

Disclaimer: I am short Waldo as this goes to press.

Thursday, November 8, 2007

The Week in Fear

Since I’m going to have to give a name to this concoction, I’m going to call it my weekly fearogram. Why not? "Fear plot" sounds a little too Halloween for my taste.

In any event, in the chart below, just like its October 22nd and October 3rd predecessors, I attempt to show how the daily SPX:VIX ratio compares to the median ratio for 18 years of data. Interestingly, the chart shows a surprising amount of fear on Monday, followed by middling sentiment on Tuesday, before an atypical amount of fear kicked in yesterday. Perhaps because the market opened in a relatively benign fashion today compared to some early futures projections, fear is actually below normal for the trading day so far.

In between bouts of intensive trading, I am back-testing this fearogram data and hoping to provide an appropriate interpretive framework soon. My initial hypothesis is that the absence of fear will make it easier for the current pullback to continue.

FXP Is Here

Talk about a timely launch!

As I mentioned last week, FXP, the double inverse of the iShares FTSE/Xinhua China 25 Index (FXI), has begun trading today. FXP is already showing up in Yahoo Finance, but has yet to appear in Google Finance.

Already showing some liquidity, FXP has traded 70,000 shares in the first 50 minutes. Watch the price and the volume on this one.

BIDU Fibonacci Targets

In measuring back to the mid-August low, I calculate BIDU's Fibonacci retracement targets to the downside to be 326 (38.2%), 295 (50%), and 263 (61.8%). This could get interesting.

Wednesday, November 7, 2007

Brian Overby on Trading VIX Options

Steven Smith of has a video interview up in which he asks Brian Overby for his thoughts on how to trade VIX options.

Overby, who is Director of Education at TradeKing and authors an informative options blog, Options Guy, tackles some of the idiosyncrasies of the VIX and has some excellent suggestions for those who insist on trading the volatility index. Frankly, there is close to 100% overlap between what he says and what I believe about the VIX.

I recommend clicking through to the video, but in a nutshell, Overby’s thinking boils down to the following:
  1. VIX options do not follow the (cash) VIX index

  2. To understand the price action in VIX options, look at VIX futures

  3. When trading VIX options, trade the front month (closest contracts to expiration)

  4. Trade VIX options when the VIX is at the extremes of its trading range

  5. Utilize a mean reversion trading strategy

  6. Look to sell vertical spreads (sell puts when the VIX is low; sell calls when the VIX is high)

Tuesday, November 6, 2007

SPDR Check: Technology and Financials

Back in August, I posted about some interesting divergences in implied volatility in the technology and financial sectors. Fast forward two and a half months and with Citigroup (C), Merrill Lynch (MER) and their brethren in the dog house while Google (GOOG), Research in Motion (RIMM) and the most of the other large cap tech stocks on a tear, the story has morphed from diverging implied volatility to diverging performance and future expectations.

So this seems like a good time to look at my favorite AMEX Select Sector SPDRs again to see what has happened. In the chart below, I compare the plight of XLF, the financial sector SPDR (XLF top holdings), to XLK, the technology sector SPDR (XLK top holdings.) Where I see the big divergence in performance is following the second week in October, from which point the financials have been beaten down almost as badly as they were during the dramatic July-August drop. The interesting part this time around is technology stocks, which fell in sympathy with financials during the summer, yet have been almost unassailable during the past three weeks.

I am skeptical that the market can continue to remain in a bullish mode without the participation of the financials, yet, on the other hand, the fundamentals of technology stocks do not seem to warrant that they join financials on the bear side of the ledger. For now at least, the bears will have to be content with claiming victory in the financial, consumer discretionary and real estate sectors, while the bulls control the majority of the remaining sectors. Eventually, I expect all the bulls or all the bears to capitulate in a dramatic major move. I’m not sure whether the move will be up or down, but each sector skirmish will provide some additional clues.

Monday, November 5, 2007

BIDU and FXI Going Separate Ways Today

Last week I detailed the components of the iShares FTSE/Xinhua China 25 Index (FXI), the ETF that began the day with a gain of 87% for 2007.

With year to date gains of 263% for the same calendar year, Baidu (BIDU), the internet search juggernaut occasionally referred to as ‘the Chinese Google’ appears to be playing a different game altogether – and in some respects it is. BIDU is not part of the FXI, but it has garnered considerable attention in the western press for its dominance in the Chinese search market. BIDU has also seemed to be impervious to the recent tech selloffs as well. This morning the stock even shook off the biggest drop in Hong Kong stocks since 9/11 as well as some negative commentary in Barrons (a preference for GOOG over BIDU) to turn a 9 point loss into a 12 point gain. While this is indeed an impressive performance, what is most impressive of all is that today’s price action in BIDU has come while the FXI has been struggling with a loss in the area of 7-10%.

All of which leads to the chart below. I have been speculating that many of the 240 points BIDU has tacked on since mid-August are at risk before the end of the year and now wonder whether the separation from FXI on the chart may not just be a visual jumping of the shark, but a metaphorical one as well. BIDU has printed several bull flags in the past few months that have proved to be pauses on the way up. If the stock continues up while the FXI heads back to earth, I will be looking to buy BIDU puts on the first sign of weakness.

Portfolio A1 Stretches Margin Over SPX to 9.6%

Continuing the strong bounce off of the mid-August lows, Portfolio A1 exited the week with fewer scars than that of the benchmark S&P 500 index. Now up 13.3% since the February 16, 2007 inception, the portfolio’s performance compares favorably to a 3.7% gain in the SPX. In spite of the recent performance, as I have discussed previously, I will retire the 100% mechanical Portfolio A1 at the end of the calendar year and replace it with a more complex portfolio that incorporates some discretionary thinking and more active management on my part.

This week one marginal performer, Shanda Interactive (SNDA), the Chinese internet company, is being dropped from the portfolio and will be replaced by StatoilHydro (STO), the state-owned Norwegian oil giant.

There are no other changes to the portfolio this week.

A snapshot of the portfolio is as follows:

Sunday, November 4, 2007

Selloff in Financials Jolts VIX; VWSI at -3

The Fed gave the markets a 0.25% rate cut, but in the 2 ½ days that followed, investors did more selling than buying, pushing the VIX up 3.45 points (17.6%) to 23.01 by the end of the week and marking the highest close in the VIX in seven weeks.

Commercial banks and other financials helped to increase investor anxiety, with Citigroup (C) and Merrill Lynch (MER) causing most of the consternation. For a superb summary of the week that was and the week that might lie ahead, I highly recommend reading up on what Barry Ritholtz at The Big Picture has assembled (I think I’ll make these links a regular feature of my weekly VWSI update):

Turning to the VWSI, the increased volatility helped to push the dial to a VWSI of -3 by the end of the week. The last time the VWSI closed the week at -3 was back in the first week of 2007, when the ‘spike’ to 12.14 initially looked like an aberration, as the next seven weeks saw the VIX close in the 10s and low 11s. Of course, everything hit the fan on February 27th and it has been a different investing environment ever since. I have no reason to predict that the current -3 reading may come at a similar juncture, but it is always instructive to look back at recent history and try to imagine how the current market lens differs from the already outdated one.

(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 -3, I suggest a versatile light red wine. No, not a Beaujolais (even though another Beaujolais nouveau release date is soon approaching) or the gamay grape behind the wine. No, not a pinot noir either. Instead, I recommend something old and something new: a barbera. This grape is widely planted in Italy and is used frequently as a blending grape, both in Italy and in the United States.

While Italy certainly produces the best know barberas, Barbera d’Asti and Barbera d’Alba, it is fruity, highly drinkable version of this wine from the Sierra Foothills that recently tickled my fancy: the 2005 Renwood Sierra Series Barbera. If you are looking for a different varietal to add to your list of everyday reds, seek this one out. For only $9 at my local wine store, it’s a bargain and a great change of pace.

If you are interested in an entertaining and informative look at Italian barbera, I encourage you to check out Gary Vaynerchuk at Wine Library TV, with The Barbera Episode.

Friday, November 2, 2007

Odds and Sods

Friday is always a good time to do some housekeeping, so here are some updates to recent themes in the blog:

In terms of fear, yesterday showed a fair amount of it, as the 25.3% increase in the VIX is about twice the median for a 2.6% drop in the SPX. While today’s markets seem to have settled down a little after an exciting opening, the elevated fear persists. For those who may be interested, you can always eyeball today’s VIX and SPX percentage changes on my fear-complacency graph to make your own assessment.

Now that the Fed may be done cutting rates for the moment (see Mike Shedlock, “Is it Two and Done?”), the good-news-is-good-news-and-bad-news-is-good-news cycle may be coming to an end as well. This means we are likely entering a Rorschach cycle, where interpretations of government data start to be largely driven by your view of the investing landscape, in addition to any psychotic disorders that may be lurking just below the surface.

In the four generals, four horsemen, etc. category, the large cap tech leaders continue to do well, while Southern Copper (PCU) has struggled a bit. The big story in the group, however, is MasterCard (MA), which saw its stock surge 20% after a blowout earnings report. Much of MasterCard’s success can be attributed to increased acceptance of plastic across the globe, rather than in the US, where growth is slowing. In fact, given the doldrums that the Retail HOLDRS (RTH) ETF has been in since July, I will be focusing closely on the many retailers who report earnings just before Thanksgiving. For some related perspectives, Toro’s Running of the Bulls argues convincingly that the four horsemen have a lot of room still to run, while Chris Perruna is following MasterCard closely.

Some quick takes for the VIXophile crowd:

Thursday, November 1, 2007

What’s in the FXI?

Now that the iShares FTSE/Xinhua China 25 Index (ticker FXI) is regularly trading 5 million or so shares per day, it would be fairly easy for a trader to make a living trading just this one basket of China stocks. It has volatility, it has options (check out the new Morningstar options data if you haven’t already), and it will soon have a 2x inverse ETF (ticker FXP) if you want to play the other side at twice the speed.

But what is in this index? Note that the China internet stocks (BIDU, FMCN, SOHU, SINA, etc.) and the China solar stocks (LDK, JASO, TSL, YGE, etc.), both recent market darlings, are conspicuously absent from the list. I have included an October 31, 2007 snapshot of the components of the FXI, with all quotes from the Hong Kong Stock Exchange:

Ten companies included in the FXI are also traded on the NYSE with ADRs. For easy reference I offer links to a Yahoo Finance version of that list in an intra-day format and also in the more detailed summary format. At the moment, all ten companies on this list are trading down 2-6% for the day, while the FXI is down 3.4% after hitting a new high of 219.56 during yesterday’s trading session.

When the FXP arrives, I will probably give it a test drive, but not until there is more convincing evidence that the FXI has put in at least a short-term top. At that point, the volume in the FXP may also provide some interesting clues about investor sentiment, specifically the breadth and depth of concern about a bubble in the Chinese stock market. For now at least, there is no reason to believe that the China trend is going to end soon and the best place continues to be on the long side.

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