Tuesday, September 30, 2008

Long the SPX on New VIX Record Closes

In light of yesterday’s record close in the VIX, a reader asked about the historical track record if one were to buy the market when the VIX made a new high.

First, let’s detail the history of new end of day highs in the VIX. Working backward, the five most recent new highs came during a span of 8/27/98 to 10/8/98 as the Russian financial crisis morphed into the Long-Term Capital Management crisis. Prior to 1998, the most recent VIX high was from 10/30/97, during the Asian financial crisis.

Looking at data from the CBOE’s historical database, which goes back to the beginning of 1990, the next three VIX highs are from August 1990. Scrolling back before the August highs, there are 11 highs in January 1990, including eight of the first ten trading days. In the chart below, I have omitted the noise from the first ten trading days and included only the last three VIX highs from the initial month of VIX data. While this leaves only ten data points, the pattern is clear: going long the SPX when the VIX makes a new high is an effective strategy, at least when the holding period is from 1 to 100 days. The mean return for the SPX following a VIX high, for instance, is about 2% ten days after the VIX high, while the mean return during all ten day periods for the SPX during the past 19 years has been only 0.3%.

For some additional mean reversion data that may be relevant to yesterday’s 34.5% VIX spike, check out a previous post, One Day 30% (!) Spikes in the VIX.

Monday, September 29, 2008

Record VIX Close of 46.72

The VIX set a new record today, with a closing price of 46.72. This record surpassed the previous record of 45.74 from October 8, 1998, which came during the Long-Term Capital Management fiasco.

Today also saw an intra-day high of 48.40 that is now the fifth highest intra-day VIX reading, behind a 49.53 reading also from October 8, 1998.

For the record, October 8th was toward the end of the panic associated with LCTM. It was the 18th day in a 1 1/2 month period that the VIX traded over 40. Following the record readings, the VIX hit 40 on each of the next four days, then did not trade in the 40s again until after the 9/11 World Trade Center attacks.

Given the heightened anxiety over the financial sector and uncertainty surrounding how and when some of the issues will be resolved, today's record does not yet look like a VIX top. The VXO hit 55.10 today (the highest reading in that volatility index since July 24, 2002) and a VIX of similar magnitude is not out of the question going forward.

VIX Top Ten Highest End of Day Closes

In Top Five VIX Spikes below, I have detailed the highest VIX values attained in an intra-day basis. In the table below, I offer up the ten highest end of day closes in the VIX. Regarding the “event trigger,” the dividing line between the Russian financial crisis and the problems associated with Long-Term Capital Management is somewhat arbitrary. For the sake of simplicity, I am counting September 21, 1998 as the break point between the Russian Financial Crisis and public knowledge of the LTCM situation.

Note that end of day VIX calculations are made at 4:15 p.m. ET, so these numbers reflect a short stretch of after hours activity.

With an hour or so of trading left to go, the current 46.38 would be a new record close for the VIX.

Top Five VIX Spikes

With the VIX spiking up to 39.59 just a moment ago, I thought it might be instructive to recap the top five VIX readings since 1990, the first year for which the CBOE has calculated VIX historical data:

Note that these readings are all dwarfed by the high of over 170 recorded by the VXO (‘old VIX’) on Black Monday 1987.

Friday, September 26, 2008

VIX Options as Catastrophe Insurance

As I type this, Congress is still debating the Troubled Asset Relief Plan (TARP) and various modifications and alternatives that have sprung up over the course of the past week.

While the outcome is uncertain, there is clearly a broad recognition that even a flawed plan announced before the markets close today may be better than the possibility of the panic and chaos we could see in global financial markets on Monday if Congress is still trying to agree on a course of action.

If there is no agreement on a bailout by the end of the day, VIX options might be one potential source of catastrophe insurance for your portfolio. Before I go any further, let me quickly add that VIX options are such a strange and difficult to understand animal that SPY or SPX puts is probably a simpler and better way for most investors to find catastrophe insurance on the S&P 500 index.

With that caveat out of the way, consider that the VIX now at about 36. It is important to understand that VIX options are not priced off of the cash/spot VIX currently at 36, but rather are priced off of VIX futures. This is an important distinction, as VIX futures for the month of October are in the 28s, the Novembers are trading in the 26s, and the December futures are trading in the 25s. For anyone looking to trade October VIX options, the underlying to focus on is October VIX futures, which is why the October VIX 20 calls are currently quoted at 8.80 – 9.10.

The second important factor to consider is that VIX futures move in a much more sluggish fashion than the cash/spot VIX index. For some supporting graphics to better illustrate how futures move vs. the VIX, try VIX Futures and Recent Market Action and VIX Futures: The One Picture to Remember. A rule of thumb is that VIX front month options generally move about half as quickly as the VIX.

If any of these thoughts about VIX options are new to you, then this is not the time to take a flier on VIX options. On the other hand, if you have an understanding on how these products work, it might be a good time to think about the VIX as portfolio insurance.

Thursday, September 25, 2008

Recent Volatility in Corporate Bonds

There is a good reason why you rarely hear about high volatility and bonds in the same sentence. It is the same reason why people don’t debate whether the grass is growing faster on Thursday than it was on Wednesday or whether the paint is taking longer to dry than usual. For the most part, bond volatility is nano-volatility.

Until last week, that is.

The graphic below (courtesy of the ISE) shows one year of pricing, implied volatility, and historical volatility for the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD). Looking solely at implied volatility, one would be tempted to conclude that March was relatively uneventful and the real difficulties in the bond market were from early May through early July. The price of the ETF and the historical volatility, however, tell another story. Rarely will you find a chart where historical volatility spiked to such dramatic levels without first seeing a rise in implied volatility that hints at what is coming.

A large part of the reason for the dramatic spike is that in addition to the general freezing of the credit markets, as recently a few months ago half of LQD’s holdings were in the financial sector. One only has to check the list of current holdings to see that LQD continues to own bonds issued by Lehman Brothers and AIG, as well as Wachovia (WB), Goldman Sachs (GS), Morgan Stanley (MS), and other names that have recently come under extreme pressure.

Depending upon your intermediate to long-term view of the U.S. economy, LQD could be an interesting buy and hold investment, if one is interested taking an approach not too different than what is being proposed by Paulson, et al. As always, caveat emptor.

Wednesday, September 24, 2008

Poll Result: Financial Crisis in Top of the 6th Inning

Thanks to all who participated in the first ever VIX and More poll, which asked readers, “What inning is it for the financial crisis?”

The results of the poll are shown at the right. The median response puts the crisis in the early part of the sixth inning; the mean response has it split between the fifth and sixth inning; and the most common response was the seventh inning.

The poll ran for one week and much to my surprise, opinions about where we are in the financial crisis did not change at all following Thursday’s rumors and Friday’s announcement concerning the Troubled Asset Relief Program or TARP.

For the record, I was pleasantly surprised by the strong response to the poll and will consider resurrecting this feature periodically in order to get a better sense of what the blog's readership is thinking about important issues.

Could 30 Be a New VIX Floor?

Yesterday a reader asked, “Have we put in a base for the VIX above 30?”

My response began as follows:

“I count five separate instances (clusters) of the VIX hitting 40 since 1990. In only one of those (1997) did the VIX not hit 40 again shortly thereafter. For the other four, we saw 5, 7, 13, and 21 subsequent days in which the VIX made it into the 40s again. Given the magnitude of the current difficulties, I would be surprised if we do not see at least one more spike into the 40s.

As for a new floor in the VIX, 30 is on the high side, but not unprecedented. We have had several instances in the past where the VIX spent two full months almost exclusively at 30 or above.”

To elaborate a little, starting in August 1998, during the height of the Long-Term Capital Management crisis, the VIX closed over 30 each day for more than two consecutive months. This feat was matched again four years later in August 2002, following the WorldCom bankruptcy and the ultimate bottoming of the dot com crash.

For what it is worth, as of last night the VIX has closed above 30 for seven consecutive days. A two month stretch of 30+ VIX closes would take us out to mid-November.

Finally, to complete my response about the possibility of a new floor of 30 for the VIX, I noted:

“On the other hand, if the country can get behind a bailout plan that shows some creativity and potential, then I would not be surprised to see volatility to slip back to the mid-20s shortly thereafter.

...at least until we dive into the housing, jobs, and consumer spending can of worms.”

Tuesday, September 23, 2008

CBOE Adds Puts to VIX Binary Option Choices

As I discussed earlier this month in VIX Binary Options, the CBOE is now offering binary options on the VIX. The first out of the gate was VIX binary calls, which were launched in July. Starting today, there are now VIX binary puts.

The CBOE noted the following about their new binary options:

"CBOE's binary options have experienced impressive volume early on, reaching as much as 10,000 to 12,000 contracts on some days and averaging 2,500 contracts daily during September. CBOE has seen strong institutional use of these contracts. Based on customer feedback, we fully expect the addition of puts to spur more brokers-dealers to come on-line to handle binaries, thus enabling more individual investors to access these products.

The Designated Primary Market Maker (DPM) for binary options on the S&P 500 Index (ticker symbol BSZ) is Chicago Trading Company; the DPM for binary options on the CBOE Volatility Index (ticker symbol BVZ) is Group One Trading, L.P.

I feel obliged to add that so far the success of the binary options has been more the result of the SPX options than the VIX options, but if you are one of those who does not expect to see a VIX in 30s for very long, VIX binary puts might be something to investigate. I can only hope that the bid-ask spreads are low enough to make these viable trading instruments.

Gold and Gold Volatility

With the unfolding of the latest chapters in the financial crisis, gold has received considerable attention as a safe haven investment. The rush into gold was greatly exacerbated when investors began to lose confidence in money market funds following the ‘breaking of the buck’ at Reserve Primary Fund last Tuesday.

One week later, there is still a great deal of fear and anxiety in the financial markets and gold is trading at its highest level in almost two months.

In the chart below, I have plotted the movements of GLD, the most popular gold ETF, along with GVZ, the CBOE’s gold volatility index (or Gold VIX) which was launched back on August 1st and is based on GLD.

As is the case with OVX (CBOE oil volatility index), there has generally been a positive correlation between the price of gold and gold volatility index. Note that in early August, the correlation between GLD and GVZ switched from positive to negative, as gold volatility began to rise even as gold prices declined. On about September 11th, however, the correlation between GLD and GVZ swung back to a strong positive one, where it has held for the past two weeks. It may just be a coincidence that this switch in correlation occurred just before a week of extreme financial panic, but I wanted to at least plant that seed and note that I will be following these and other related subjects as I evaluate some of the new volatility indices in this space going forward.

[source: VIX and More]

Monday, September 22, 2008

Market 2.0

So far we are 1 ½ hours into Market 2.0 and the picture looks like a throwback to earlier in the year. Gold, oil and commodities in general are in the green and almost every other sector is in the red, with financials, airlines, and real estate logging the largest losses.

The chart below, courtesy of StockCharts.com, details U.S. sector performance through 11:00 a.m. EDT. If the sector performance looks familiar, it could be that the trends bear a strong resemblance to those I recorded back on January 1st in Sector Clues in First Hour of 2008?

Friday, September 19, 2008

Puts Instead of Shorts?

The table below shows call and put activity at the International Securities Exchange (ISE) during the first two hours of today’s trading. Keep in mind that the ISEE is a “call to put” ratio, not the “put to call” ratio reported by the CBOE.

As reflected in the table, right out of the gate there was a flood of calls for indices, ETFs, and individual stocks. Note that in the last hour or so, the activity has tilted heavily toward the put end of the spectrum, as the call to put ratios have dropped dramatically. It is difficult to differentiate between hedging and speculation in these transactions, but now that options spreads seem to be tightening and implied volatility is dropping sharply, I suspect those looking to get short financials and any other part of the market may be leaning toward puts.

It will be interesting to see how the options market is affected by the new shorting regulations.

[source: International Securities Exchange]

New Game, New Rules

Earlier this week, I was thinking about what might qualify as the five most important events in my lifetime. I came up with the following list, which perhaps reflects my personal perspective on the world more than anything else:

  1. Cuban Missile Crisis (I was born a little after JFK was inaugurated, so I can’t go back much further in time than this)
  2. 9/11
  3. Passage of the Civil Rights Act
  4. Falling of the Berlin Wall / Breakup of Soviet Union
  5. Nixon’s Resignation / Watergate

Not quite making the cut were the first moon landing and moon walk, the creation of the internet, and various other advances in science and technology.

I had wondered if the events of this week would make it on that list. While it is too early to tell, my initial gut reaction is that if the financial markets had a constitution, we have essentially just ripped it up and declared martial law. Things may meander back toward the way they used to be, but I don’t think the markets will ever be the same going forward, given what has just transpired, regardless of what the consequences turn out to be.

Many have written eloquently about recent events, but there are three posts from this morning that I wish to highlight:

Thursday, September 18, 2008

VIX to 42.16...But Will It Hold?

So we have a new line in the sand right now, a VIX of 42.16 (and SPX of 1133).

Note that when the VIX continues to spike to new highs even as the markets are not making new lows, then we have extreme fear.

To answer a question in a post below, there is no reason why the VIX cannot spike above 45 today, though I do not expect that to happen.

In terms of a potential bottom, the big fly in the ointment is the calendar. Tomorrow is options expiration, which is followed by a weekend in which I can't imagine many investors will be comfortable with large long positions. As a result, if the markets do not show some strength in the second half of today's session, they are not likely to be strong tomorrow or Monday morning.

VIX Spikes to 38.32

Moments ago the VIX spiked to 38.32, the highest VIX level recorded in the past six years surpassing the 37.57 VIX spike back on January 22nd.

With the weekend coming up and so much uncertainty in the markets, I am concerned that we may still be several sessions away from a Brunhilde Day. On the other hand, a strong finish today on impressive volume and lots of breadth would help to make the case for an intermediate-term bottom.

VIX:VXV Ratio at New End of Day High

As far as I know, I was the first person to show interest in the VXV as a market timing indicator and the first to talk about the VIX:VXV ratio when I posted on these subjects back in early December in The VIX:VXV Ratio.

Fast forward nine months and the VIX:VXV ratio has an admirable market timing record and a very strong following, here and elsewhere. Last night it set a new end of day high when the ratio closed at 1.20. So far, readings of 1.08 and above have been good long entry points. Using the same logic, a long entry at 1.20 should be an even better trade. I will be interested to see how last night’s signal turns out.

[source: StockCharts, VIX and More]

Wednesday, September 17, 2008

Volatility Catastrophe Graphic

Catastrophe may not be exactly the right word here, but I needed a title with which to introduce the graphic below, which is a ratio of the VIX to the 3 month T-bill yield (VIX:IRX ratio).

The chart goes back to beginning of the VIX data in 1990 and even in a log scale demonstrates that the current environment is several orders of magnitude more concerning (at least from a volatility and flight to safety perspective) than any other day in the last 19 years.

For more background on this particular ratio, check out Expanding on the VIX and the 10 Year Treasury Note Yield and Fear and the Flight to Safety.

[source: StockCharts]

SPX:VIX Ratio Sets Record for Distance Below Trend Line

There are many extreme numbers being generated by the current panic in the markets. Since this blog emphasizes volatility, I wanted to share one that takes a long-term view of volatility: the SPX:VIX ratio.

In the chart below, I have created a graphic which tracks the ratio back to the first VIX data from 1990. In addition to the ratio (black line) and SPX (gray area chart), I have also included a blue line that represents a 10% long-term trend line for the SPX (for additional information, try The SPX:VIX Relationship). The key takeaway is that the SPX:VIX ratio is now farther below the trend line than it ever has been during the 19 years of VIX data.

Incidentally, the SPX:VIX ratio has been declining steadily since January 2007, some 21 months ago. As long as the 2000-2002 bear marked seemed, the SPX:VIX ratio trended down only three months more (24 months) during that bear stretch.

The SPX:VIX ratio tends to be mean-reverting around the long-term trend line, but as the graphic shows, the path back to the mean can be a long and difficult one.

[source: StockCharts]

Fear and Large VIX Spikes

We are starting to finally see some real fear today, for the first time in a long time.

Regarding fear and large VIX spikes, my thinking is that the setup for a big VIX spike comes only after market participants begin to believe that a bottom is in and a sharp move downward suddenly causes them to change their mind. The mind set switches from something like "it's finally safe to be long again" to something along the lines of "oh no, this is much worse than I though...and I am caught on the wrong side of it."

Part of the fear factor is the fear that something unknown and/or much larger than expected is at work.

Tuesday, September 16, 2008

CDR Counterparty Risk Index Swamps March High

Credit Derivatives Research has a Counterparty Risk Index (and a number of related sub-indices) which calculates the average credit spread of the 15 largest credit derivative dealers. Following the recent turmoil in the credit markets, the index now stands more than 50% higher than the previous March 2008 high.

Not surprisingly, the Markit CDX (credit default swap) indices are seeing similar spikes.

[graphic courtesy of Credit Derivatives Research]

VIX:VXV Ratio at 1.16

The VIX:VXV ratio spiked to 1.16 at the open today, suggesting a high probability of an imminent reversal of the short and intermediate trends.

Put to call and other contrary sentiment indicators are supporting this reading.

Of course, the market is being driven by news of deteriorating macroeconomic conditions and fundamentals right now, so it may take longer than usual for this extreme sentiment reading to reverse.

Monday, September 15, 2008

VIX Spikes and the 2002 Market Bottom

With the VIX spiking over 30 this morning and investors wondering if the markets will ever find a bottom, this seems like a good time to talk about VIX spikes and market bottoms. Specifically, I want to dispel the myth that bear markets have to end in some grand capitulation climax that includes a dramatic volatility spike.

A perfect counter example to the VIX spike requirement can be found in the bear market that followed the NASDAQ boom which crested in March 2000. In fact, with the exception of the current bear market, the 2000-2002 bear market is the only bear market since the launch of the VIX back in 1993 or the historical reconstruction of VIX data by the CBOE that dates back to 1990.

Rather than use the SPX and the VIX to demonstrate my point, the chart below uses the NASDAQ-100 index (NDX) and its companion volatility index, the VXN. The reason I chose the NDX is that from the March 24, 2000 peak (4816.35) to the October 8, 2002 bottom (795.25), the NDX lost an astonishing 83.5% of its value. If there was ever an opportunity to witness a dramatic drop and capitulation, this was the market and index in which to see it happen.

If one looks at a chart of the NDX and the VXN for the period 2000-2002, five distinct VXN spikes stand out. I have highlighted these with a blue vertical line for easy reference in the chart below. It turns out that those who went long at the time of these volatility spikes saw anywhere from two weeks of a bounce to several months of mostly sideways action. None of these spikes signaled a lasting market bottom.

When the NDX finally hit bottom (marked by the red vertical line and arrow), the VXN barely moved at all. Yes, the nastiest bear market of the last two decades ended with a volatility whimper. I like to call this type of bottoming action a "stealth bottom."

Capitulation comes in all shapes in sizes. Most bottoms are marked by a VIX spike. If, however, you assume that volatility spikes will mark the bottoms and bottoms cannot form without a VIX spike, you will be overlooking an important lesson from perhaps the most important recent bear market.

[source: StockCharts, VIX and More]

Friday, September 12, 2008

Brazil Finding a Bottom?

As I noted yesterday in The U.S. VIX vs. a BRIC VIX, emerging markets have been struggling mightily in the past few months.

An excellent example of the weakness in emerging markets can be found in Brazil, where the Brazil country ETF (EWZ) fell 44.3% from a late May high to a low that was made yesterday. Now picking bottoms is a game best suited for those who are long on hubris and short on common sense, but there are several factors which lead me to believe that yesterday’s low may turn out to be an intermediate or long-term bottom.

From a purely technical perspective, the chart below shows Tuesday as the lowest close (omitted is the intra-day 52 week low from yesterday). Also on Tuesday, EWZ’s options volume hit a new high for 2008 and implied volatility spiked to levels not seen since the March panic. Of course, none of these factors guarantees a bottom, but taken together, and given the relative strength of EWZ once again today (up over 4% as I type this), they increase the likelihood of a profitable entry.

[source: International Securities Exchange]

[Disclosure: long EWZ at time of writing]

Thursday, September 11, 2008

The U.S. VIX vs. a BRIC VIX

India has an India VIX, Germany has the VDAX, and some other countries (largely in Europe) have their own country volatility indices. Outside of North America and Europe, the volatility index pickings are slim, however, so when you want to get a sense of international volatility on a broader scale, you have to roll your own.

Which is exactly what I have done today.

In the chart below, the bottom half is a six month chart of implied volatility in the S&P 500 index. It is similar, but not identical to the VIX. Note the March high, a second peak in mid-July, and the recent uptrend in volatility.

On the top half of the chart is the implied volatility in the Claymore BHY BRIC (Brazil, Russia, India, and China) ETF (EEB), which attempts to replicate the performance of the Bank of New York BRIC Select ADR index. In contrast to the SPX, implied volatility in the BRIC ETF was relatively moderate in July, but has spiked dramatically over the course of the past two weeks. In short, fear and anxiety may be rising slowly in U.S. markets, but in the critical economies of Brazil, Russia, India, and China, signs of panic are much more widespread.

If emerging markets are the buffer whose continued growth is supposed to buttress developed markets in this economic slowdown, then emerging markets need to find their own firm ground and soothe anxious investors before they can be expected to lubricate the wheels of the global economy.

[source: International Securites Exchange]

Wednesday, September 10, 2008

VXN:QID Ratio Reflects Unusual Complacency

With the Fannie/Freddie bailout getting no better than mixed reviews, the U.K., Germany, and Spain apparently headed for a recession, and continuing turmoil in emerging markets, sometimes I am surprised to see any green at all on my screen.

On the other hand, I’m sure some are wondering how close we can be to a collapse in the world’s financial system if the VIX is trading in the 24s.

It’s a valid question – and one I have addressed in the past on the blog with the benefit of several indicators which help evaluate how much complacency is in the market. One of these is a ‘fearogram,’ which measures the ratio of changes in the VIX to changes in the SPX. A similar tool is the VIX:SDS ratio, which compares the relative movements of the VIX and SDS (the double inverse ETF for the SPX) to historical patterns.

Below I have created a chart of the VXN:QID ratio, a sister to the VIX:SDS ratio. This chart compares volatility in the NASDAQ-100 index (NDX) to the double inverse ETF for the NDX. There are (at least) three ways to think about complacency in this chart:

  1. the absolute level of the ratio
  2. the level of the ratio relative to the 10 day simple moving average
  3. the level of the ratio relative to the 100 day simple moving average

Looking at the chart, consider that lower readings generally correspond to lower levels of complacency (i.e., less volatility and fear per unit of decline). The current ratio is moderately low on an absolute scale, but is lodged neatly between the 10 and 100 day SMAs. What I find particularly interesting about the chart is that in those instances in which the VXN has experienced a sustained rise over a period of several weeks or more (see top section of graphic), the current situation is the first time the ratio has not risen on par with the VXN. This development is a divergence worth watching and one which appears to favor the bears.

[source: StockCharts, VIX and More]

Thanks to all who responded to my call for help about creating blog posts in Word and publishing them to Blogger. For the record, this is my first post using Windows Live Writer, which has been up to the task so far...

Tuesday, September 9, 2008

Treasury Inflation-Protected Securities and Inflation Expectations

First there was the inflation scare, then there was the deflation scare, and now it seems any network or blog can find enough economists to support either scenario as a grave concern for the economy.

In times of confusion, I like to take my cues from the markets. This time around I am talking about the future inflation rate expectations that can be derived from Treasury Inflation-Protected Securities, more commonly known as TIPS. Using the CPI as an inflationary benchmark, TIPS coupon payments and the underlying principal are automatically adjusted to account for inflation. With a couple of assumptions to mitigate a liquidity premium and inflation-risk premium, a market assessment of inflationary expectations can be derived from the difference in yield between nominal treasury notes and TIPS, which is exactly what the graph below shows.

Based on the TIPS yield differential analysis, it appears as if inflationary expectations peaked in either late February or late June and have been steadily trending lower over the course of the past two months, to the point that current inflationary expectations are at levels not seen in at least ten months.

[source: Federal Reserve Bank of Cleveland]

A Technical Aside: How to Best Create in Word and Publish in Blogger?

It has been 20 months since I started blogging and during that period, Blogger has turned out to be a surprisingly reliable platform. Blogger is not without its shortcomings, but all things considered, I have been relatively happy creating posts in Microsoft Word, pasting them into Blogger, and adding the finishing touches with Blogger's own functionality.

Recently, however, whenever I paste something from Word into Blogger, the formatting has not translated properly. At first, I would edit the HTML manually in Blogger, with reasonable results given the effort required. This was an acceptable workaround when most of the rogue HTML code preceded the text of my post and could easily be stripped out in one step. Now the quantity of extra Word-generated HTML seems to be increasing and I find myself left with the option of pasting all the extraneous HTML from Word into Blogger or using an intermediate step such as Word->Notepad->Blogger to strip out all formatting, then reformatting the post and adding all HTML from scratch in Blogger. Neither approach is the streamlined process I am looking for (and enjoyed until recently.)

I have investigated a number of alternatives and have yet to find a satisfactory one. Ideally, I would like to create a post in Word and publish it to my blog in one step, without the loss of any links and formatting I create in Word. There must be some good solutions out there. Readers, what can you recommend?

Monday, September 8, 2008

The Value of Selling Covered Calls

One subject that gets less attention than it deserves is the value investors can extract from selling covered calls. To be fair, a covered call strategy sacrifices what can sometimes be considerable upside in exchange for a fixed return, but this can be a highly effective strategy in a range-bound market.

The chart below is a weekly chart that shows the CBOE S&P 500 Buy-Write Index (BXM), which is designed to replicate a buy-write or covered call strategy for the S&P 500 Index. Note that during the recent bull market, a buy-write strategy resulted in roughly the same returns as owing the SPX, but with less volatility.

[source: StockCharts]

More importantly, over the course of the last year, a buy-write strategy has significantly outperformed the SPX. The details can be seen in the next chart, where a relatively new ETF, the PowerShares S&P 500 BuyWrite Portfolio (PBP) has lost value at less than half of the rate of the losses in the SPX.

In sideways markets, in down markets, and even in up markets, a buy-write or covered call approach like that of the PBP (or first cousins BEP and MCN) can be an excellent way to increase returns and reduce risk.

[source: BigCharts]

Friday, September 5, 2008

Global Equities Falling Through Support

The U.S. markets may look ugly right now, but the global picture is even worse. Pull up a chart of the South Korean KOSPI if you really want to see an ugly market.

For an ETF with global perspective, I am a fan of the iShares S&P Global 100 Index ETF (IOO), which is comprised of 100 large cap (average $10 billion) multinational companies that are selected based on the firm’s percentage of foreign assets, revenues, and employees. For more details, check out the S&P 100 holdings.

As the weekly chart of the IOO shows, the deterioration in the global equity picture has accelerated dramatically this week, with stocks falling through technical support and bringing the IOO back to levels not seen since July 2006. If IOO cannot hold the 2006 support level of 61.00, then another even uglier leg down is certainly a distinct possibility.

[source: StockCharts]

Thursday, September 4, 2008

Mortgage Resets: COFI Numbers Improving

There have been countless graphics floating around the media outlining the large quantity of adjustable rate mortgage (ARM) rate resets that are anticipated in the coming months and years. For some excellent background and analysis on the subject of ARM resets, I encourage readers to investigate what Calculated Risk has to say on the subject.

One of the silver linings in the global economic slowdown is that as interest rates continue to fall, these ARM resets are going to be executed at rates which are increasingly favorable to borrowers. Setting aside the flip side – that lower rates will be less favorable to already struggling lenders – the prospect of lower ARM rates may help to accelerate the formation of a housing bottom and will certainly provide consumers with additional disposable income.

In the chart below, I have constructed a ten year history of the 11th District Cost of Funds Index (COFI) data. The COFI is one of the most widely used ARM indices. As the graphic indicates, COFI has fallen from 4.4% in September to 2.7% in July. It has dropped 1.3% since the beginning of the year and is now at one of the most affordable levels of the past decade.

[source: VIX and More]

Wednesday, September 3, 2008

VIX Binary Options

Back on July 1st, the CBOE launched binary options on the VIX. Essentially the CBOE’s binary options are the same as the pioneering ‘fixed return options’ launched by the AMEX earlier in the year.

As the name implies, a binary option is an all or nothing security that pays off a fixed cash settlement amount if the underlying settles at or above a specified strike price at expiration. If the underlying settles below the specified strike price, the binary option will expire worthless. If you are familiar with Intrade.com, then you are already familiar with binary options.

In the case of VIX binary options, these are European style (no early exercise) options, currently consisting only of calls (no puts are available), and settled in cash. The CBOE specifies the settlement as follows:

"The exercise-settlement value for VIX Binary Options will be the same as the exercise-settlement value ("VRO") for CBOE Volatility Index Options. VRO is a Special Opening Quotation (SOQ) of VIX calculated from the sequence of opening prices of the options used to calculate the index on the settlement date. The opening price for any series in which there is no trade shall be the average of that option's bid price and ask price as determined at the opening of trading. Exercise will result in delivery of cash on the business day following expiration.

The exercise-settlement amount for VIX Binary Call Options will be 1) $100, if VRO is equal to or greater than the VIX Binary Call Option strike price; or 2) $0, if VRO is less than the VIX Binary Call Option strike price."

I checked with my two favorite options brokers, thinkorswim and optionsXpress, to determine the availability of VIX binary options. thinkorswim has not yet implemented VIX binary options, but is “working on adding them.” optionsXpress does have VIX binary options available to trade. To access the optionsXpress VIX binary options chain, just pull up the chain for options on VRO (the VIX special opening quotation ticker).

A graphic of the current optionsXpress VIX binary option chain is below. As you can see, volume and open interest are negligible at this stage, which has translated into bid-ask spreads generally in the 0.06 – 0.10 range. For the month of August, the 22,162 VIX binary options contracts traded accounted for 1.8% of all VIX call options and 1.1% of all VIX options transactions.

For additional information, check out the VIX binary contract specifications at the CBOE’s web site.

[source: optionsXpress]

Tuesday, September 2, 2008

August Sector Recap

August was a month in which the S&P 500 largely drifted sideways, but there was a good deal going on in the various sectors that make up the index. The graphic below shows sector performance for the nine sector SPDRs for the first eight months of 2008 (bottom) and for the month August (top).

On the plus side, the turnaround in the consumer discretionary sector (XLY) is clearly responsible for much of the recent positive momentum in the SPX. Also worth noting is that four other sectors outperformed the index in August: consumer staples (XLP), health care (XLV), industrials (XLI), and technology (XLK).

As has often been the case during the past few months, when the SPX has been moving up, energy (XLE) and materials (XLB) have been moving in the opposite direction. In August, the financial sector (XLF) was also pulling the index in the wrong direction.

Watch the consumer for more clues about sector leadership and overall market strength in the month of September.

[source: StockCharts]

Portfolio A1 Performance Update: 8/31/08

As previously promised, I am now providing a monthly performance update for Portfolio A1, which I launched live on the blog a little over 1 ½ years ago.

The chart below shows the equity curve and some summary performance statistics for Portfolio A1 since the equities only (no ETFs or options), long only portfolio was created on February 16, 2007. During the 18 ½ months since inception, Portfolio A1 has posted a cumulative return (exclusive of dividends) of 4.2%, while the benchmark S&P 500 index has declined 11.9%. This adds up to a net performance of +16.1% for the portfolio vs. the benchmark.

As of August 31, Portfolio A1’s holdings included: Cleveland-Cliffs (CLF); ENGlobal (ENG); Cash America (CSH); EnerSys (ENS); and Centene (CNC). For the record, Portfolio A1 also shares some common ancestry and has a stock ranking system that is similar to the VIX and More Focus Aggressive Trader model portfolio – one of the four model portfolios that I update transaction by transaction for the VIX and More subscriber newsletter.

As a reminder, Portfolio A1 was created with tools developed by Portfolio123.com and is managed via Portfolio123.com’s tool set. For more information on Portfolio123.com, please refer to an earlier post on the subject, Portfolio123.com: The Engine Behind Portfolio A1.

[source: Portfolio123.com]

DISCLAIMER: "VIX®" is a trademark of Chicago Board Options Exchange, Incorporated. Chicago Board Options Exchange, Incorporated is not affiliated with this website or this website's owner's or operators. CBOE assumes no responsibility for the accuracy or completeness or any other aspect of any content posted on this website by its operator or any third party. All content on this site is provided for informational and entertainment purposes only and is not intended as advice to buy or sell any securities. Stocks are difficult to trade; options are even harder. When it comes to VIX derivatives, don't fall into the trap of thinking that just because you can ride a horse, you can ride an alligator. Please do your own homework and accept full responsibility for any investment decisions you make. No content on this site can be used for commercial purposes without the prior written permission of the author. Copyright © 2007-2023 Bill Luby. All rights reserved.
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