Friday, October 31, 2008

Watch Emerging Markets Bonds

I know a number of equities-only investors who have started following the bond markets for the first time ever over the course of the past year after becoming tired of being blind-sided by inter-market relationships.

Of the many credit market data points, LIBOR, the TED spread, OIS-LIBOR and others have received a fair amount of press as of late as measures of liquidity. More traditional bond market indicators focus more on risk than liquidity and include the spread between corporate and government bonds or between investment grade and high yield corporate bonds.

I want to suggest another bond market indicator – one that can provide a reflection on the workings of the global economy. The PowerShares Emerging Markets Sovereign Debt Portfolio is an ETF that carries the ticker PCY. Launched in October 2007, the one year chart shows historical volatility in the 5-10% range prior to the Lehman Brothers collapse last month. Historical volatility is now above 100% after a month and a half of pure chaos. As the chart below shows, PCY lost almost half of its value during the past month and appears to have bottomed last Friday. Note the new buying interest over the course of the last few days, as investors have sought out emerging markets debt as a value play.

In many ways, emerging markets are the focal point of many of the issues facing today’s global economy, from the credit crisis to the demand for commodities to the prospects for renewed global growth down the road. Keep an eye on PCY, not only as an indicator, but also for its investment potential.

[source: StockCharts]

Thursday, October 30, 2008

Recent Volatility and VIX Macro Cycles

The science art of forecasting volatility more than a couple of weeks out has always struck me as a lot more like astrology than astronomy, so it was with some mild apprehension that I thought I should update my VIX macro cycle chart here and see what previous posts in this area predicted for 2008.

The good news is that in December 2007 in Was 2007 the Beginning of a New Era in Volatility?, I managed at least to nail the persistence of the recent trend by noting, “the current rise in volatility should persist through all of 2008, even if the rate of rise in volatility begins to slow.” In what looked like a much safer prediction, I said, “the rate of change in volatility over the course of 2007 is unsustainable going forward – or at least inconsistent with the slope of volatility macro cycles during previous cycles.” As the monthly chart below shows, the VIX essentially moved sideways to down from July 2007 through August 2008, at which point the recent volatility began in earnest.

My most recent VIX macro cycle update comes from March 19, 2008, just three days after Bear Stearns was sold to JP Morgan (JPM). At that point in time many believed volatility seemed to understate the gravity of the financial turmoil. For historical context, I will repeat my assessment at the time:

I still anticipate that volatility will spend a good portion of 2008 in the neighborhood of 22-26. Looking at the current VIX futures quotes, where the May through December futures are all trading just below 26, it looks as if my prediction is on the low end of the market consensus.

The big question I have is about the duration of current VIX macro cycle – and of course the slope of any continued increase in volatility. If the current slope of the volatility increase holds and the minimum cycle time is two years, that would project to a sustained VIX of about 40 by the end of the year. I don’t expect to see that scenario unfold, but it will be interesting to see how long it takes for the runup in volatility that started about 15 months ago to run out of steam.

So…7 ½ months later I can say that my prediction held up through mid-September, but once Lehman Brothers filed for bankruptcy, the LEHVIX and VIX went through the roof and my predictions went out the window.

From a macro cycle perspective the two questions to ask now are how long the current cycle of increasing volatility should last and what direction the next cycle will take. Using the historical norms of a 2-4 year cycle and considering the steep trajectory of the recent 22 months of increasing volatility, I suspect that the current cycle is nearing an end and either topped out at the beginning of the week or will see one final topping move in the next month or two.

The direction of the next move is the bigger question and the more difficult one to answer. Two of the three previous changes in volatility have ended in a multi-year sideways move. Given some of the structural and fundamental challenges currently facing the economy, the easier prediction to make seems to be several years of elevated volatility.

I am going to go out on a limb, however, and stick to my fear bubble thesis to predict that volatility will be on the wane over the course of the next two years or so. Don’t succumb to anchoring when it comes to a VIX of 70. Just two months ago the VIX was in the teens. While it may be awhile before the VIX returns to the teens, I would not be surprised if the VIX were back in the 20s in another 2-3 months.

Of course, a large part of the path forward will be strongly influenced by the policies and regulations put into place by governments that have yet to take office – all of which substantially increase uncertainty around any prediction.

[source: StockCharts, VIX and More]

Wednesday, October 29, 2008

Is the Fear Bubble Bursting?

There have been quite a few bubbles and mini-bubbles that have burst over the past year or so. A short list would probably include China; housing; oil; fertilizer; solar; dry bulk carriers; etc.

What about a fear bubble?

We have overshot on just about everything else, so maybe it’s time we overshot the whole business of overshooting. Fear and volatility have become so much a part of the everyday existence for those who work in the investment world that it is all too easy to take them for granted.

When I see a contract on Intrade that allows people to bet on the end of western civilization, then I’ll know things have gone too far. I haven’t seen such a contract yet, but I feel obliged to note that there is a contract for The U.S. Economy to go into a Depression in 2009, with a depression defined as “a cumulative decline in GDP of more than 10.0% over four consecutive quarters.”

Looking at previous bubbles, I wonder if the fear bubble is analogous to an oil bubble. You see macroeconomic events moving inexorably in the same direction day after day and you begin to assume the future is a predestined march down what looks like an unavoidable path.

On Monday, in Fear Is on the Decline, I talked about signs I was seeing that fear was already “starting to leave the markets.” The VIX has already fallen more than 15% from Monday’s close and there is a good chance it will be at least another decade before it sees the 80s again.

Roger Ehrenberg is out with another thoughtful piece, Is Volatility Embedded in the System for a Generation? In it, Roger paints a picture of a financial crisis receding only to the point that it exposes gaping fundamental holes in the economy, the substantial risk of a Japan-style deflation, and a Fed so determined to prevent deflation that their easy money policy leads to runaway inflation and ultimately some sort of cruel game of low growth inflation-deflation ping pong.

In such an environment, which I would not consider to be too far-fetched, Roger describes a VIX of 40 as the new 20 and predicts a much higher floor for volatility in the future.

On the other hand, I am reminded of a post I titled The Big Question for the VIX back on May 22nd when the VIX closed at 18.05. The big question back then, with a financial crisis raging, oil approaching 150, and investor anxiety on the increase, was why the VIX was below 20.

Just five months ago, which was the more unlikely scenario: crude oil at 60 or the VIX at 90? It’s hard to say, but suffice it to say that it would have been hard to find the appropriate strikes to even make such a bet back then.

In the last five months, cause and effect has flipped. Not too long ago it was oil prices that were driving estimates of future economic activity and volatility, now the economy is the cause and oil, volatility and the like are the effects.

One day of 900 points gains in the Dow Jones Industrial Average will not fix all the economic woes on the horizon. It just might, however, signal an end to the runaway bull market in fear.

Tuesday, October 28, 2008

SPX Put Bomb Update

Last Wednesday, in SPX Options Carpet Bomb Pushes VIX SOQ to 63.04 (!) I reported on a series of transactions involving some 285,000+ SPX put contracts that one party apparently purchased at the open. At the time, my angle on these transactions focused on the ability of the purchaser to artificially create a sharp jump in the ‘special opening quotation’ in the VIX that is used to settle VIX futures and options.

As it turns out, whoever bought those puts did not need to make any money on their VIX positions. If they held on to those SPX puts for just three days, their positions gained 96% and if they held them through yesterday’s close they would be up some 124%. That is a gain of over $180 million according to my calculations. Not bad for less than a week of work…

Monday, October 27, 2008

Record Close for VIX: 80.06

With the VIX under 75 and only ten minutes left in the trading day, it looked like volatility was on the wane, but aggressive selling into the close dropped the DJIA 200 points and helped to push the VIX up over the 80 during the extra 15 minutes of index options trading.

This is the first time the VIX has closed over 80 and the 8th time in the past 16 trading days that the VIX has registered a new record close.

A Week By Week Look at the Past Six Months

The graphic below, which I usually reserve for the subscriber newsletter, shows a six month snapshot of the weekly performance of 17 indices and ETFs that I watch closely.

I am going to let this table go largely without comment, other than to note that I have bolded the largest percentage changes up and down (excluding the VIX) for each week and have grouped the weeks into four sets of 5-10 week chunks.

There are some amazing numbers in this graphic and some day when the VIX is at 14 and change, we can all look back at what was going on during this period and crack a small smile, knowing that we persevered.

[source: VIX and More]

Fear Is on the Decline

With the VIX currently at 77.13, it may seem like a strange time to talk about fear starting to leave the markets.

As I type this the VIX is down 2.00 and the SPX is down about 15. The fact that the VIX and SPX are both moving down this morning is unusual, but not unheard of. What makes the situation even more interesting is that it is happening on a Monday, when the VIX typically 'springs ahead' to account for the 'calendar reversion' effect in which the VIX is priced according to the calendar, but only calculated during trading days. The long and the short of this is that market makers tend to drop option prices on Fridays in anticipation of the coming weekend and raise them on Mondays.

We now have two Mondays in a row without any of the jaw-dropping end-of-the-world headlines many investors have come to fear. For that and other reasons, there markets seem to be less caffeinated this morning and the VIX is finally starting to feel the effects of gravity.

Pre-Market Futures Volatility

NASDAQ futures down over 55 at one point, now almost even with five minutes before the open

Friday, October 24, 2008

Two New VIX Records

The VIX established a new intra-day record of 89.53 and end of day record of 79.13, obliterating the previous records from last week by more than 8 points each.

Today's action marked the third Friday in a row that the VIX established a new record close. The VIX has now closed over 50 for 15 consecutive sessions, with the 10 day moving average now up to an even 64.00.

Last 90 Minutes Will Be Critical

Anything less than a strong rally will put a 'Bleak Monday' into play

Relative Strength in Rails, Metals, Natural Gas, and Ag

Buyers are stepping in and pushing some stocks in these sectors into the green.

First VIX Print Is 89.00

Markets rallying in first three minutes

Futures Limit Down; Today Will Be Very Ugly

...and probably start a new round of "adverse reaction loops."

Don't be surprised to see the VIX over 100.

Global markets are in panic mode prior to the U.S. opening:

[source: CNN]

Should You Go Long at Volatility Extremes? A Look at the Nikkei 225

Japan’s Nikkei 225 stock index is the primary index used to track the Tokyo Stock Exchange. It was also the index that captured the fall of the Japanese stock market from 38,959 on the last day of 1989 to 7,603 in April 2003, a drop of 81% over the course of more than 13 years.

The Nikkei, therefore, provides an opportunity to test the idea of whether it is profitable to initiate new long positions in times of extreme volatility, even in prolonged bear markets.

In order to test this hypothesis, I reviewed the data for the Nikkei 225 from 1984 to the present and singled out the ten most volatile days during this period, using various volatility measures such as historical volatility and average true range. The result, which includes a number of overlapping days and clusters of similar volatility extremes, is displayed graphically in the chart below, courtesy of In the chart, the seven instances with the highest volatility levels are highlighted by green arrows. Note that in each case a rally of at least two months followed these volatility extremes. In the one bull market example, the new bullish trend lasted for two years; in all the other bear market examples, the new bullish trend lasted from two months to 1 ½ years.

For the record, the action in the last two weeks in the Nikkei would make the current environment the most volatile of all instances, just as is the case for the S&P 500 at the moment.

While all bear markets are not created equally, Japan's "lost decade" does bear some resemblance to the problems in the U.S. Looking at the historical record with a global perspective, it is tempting to conclude that the current situation ripe for another volatility bounce of at least two months.

[source: StockCharts]

Thursday, October 23, 2008

VIX at 79.43 as Panic Deepens

A new record high close for the VIX is all but assured at this point.

Buyers have been afraid to step in front of the freight train during the past three hours, thought it is never easy to predict what the last 90 minutes will bring.

For those who have asked, the VIX technically has no upper boundary.

Rare Batman Pattern Forming in VIX

Just as it seemed as if the end of the world was nearing, I am pleased to report a rare Batman pattern forming in the VIX (and in the implied volatility of the SPX and SPY).

The chart below shows the right wing formed two weeks ago, just as panic was first setting in; the head was completed last week, when the situation looked most bleak; and now the left wing is taking shape as the forces of good seek to gain the upper hand over the forces of evil.

Once the Batman pattern is completed, perhaps as soon as tomorrow, I can only conclude that Gotham City will likely be spared the full force of the financial Armageddon that appears to be bearing down on us.

Godspeed, Batman. Every minute counts…

[source: International Securities Exchange]

Wednesday, October 22, 2008

SPX Options Carpet Bomb Pushes VIX SOQ to 63.04 (!)

Kudos to Adam at Daily Options Report for getting all over the VIX expiration story a little earlier. In Time for an In-VIX-Tigation? Adam wonders about the large number of SPX options trades at the open today.

In the table below, I have reconstructed the details of this attack, which appeared to involve the purchase of close to 300,000 puts (all of which were opening transactions for that strike) and a grand investment of about $150 million.

This transaction pushed the VIX from a close of 53.11 on yesterday to a special opening quotation (for the settlement of VIX options) of 63.04, a 9.93 (18.7%) jump over yesterday's close. If I am able to unearth any additional details about this transaction, I will pass them along.

[source: VIX and More]

CBOE Offers New VIX Term Structure Data

I noticed today that the CBOE has decided to devote a portion of the VIX section of their web site to VIX term structure information. The CBOE’s VIX term structure page, which I believe is new as of yesterday of today, uses yesterday’s data and has a graph of the term structure of the VIX and a table of VIX term structure data going out through December 2010. In addition, there is a downloadable spreadsheet with historical term structure data going back to 1992.

For those interested in getting a better sense of the VIX, understanding the term structure of the VIX is an essential step in that process.

Tuesday, October 21, 2008

VIX Drops 20% in One Day…Again

Sometimes a big move in the VIX is significant and sometimes it is a lot harder to interpret. On the surface, yesterday’s 24.7% drop in the VIX – the second largest one day move down in percentage terms – appears to fall in the latter category.

From 1990 through 2005 the VIX fell 20% on only two trading days: once in 1993 and once again in 1994 (see green arrows in top graphic). Each instance signaled a bottom and about a three week bounce. The markets then moved up sharply in 1995, but it is a large stretch to say that the VIX offered any signal about a move that was at least nine months away.

After an 11 year drought, an uptick in volatility brought the 20% drop back into vogue in the middle of 2006 and including yesterday, there are now six such instances in the past two years and four months. The bottom chart also marks these 20% drops with green arrows, which once again tend to signal bounces of no more than about three weeks.

In general, I do not consider a 20% one day drop in the VIX to be particularly significant. In most cases this is merely a statistical quirk which results from the typical mean reversion process that appears while volatility retraces the path of a previous upward VIX spike. In such instances, the initial VIX spike is the more noteworthy event.

Now for one of my favorite phrases: “But this time it’s different!”

In all fairness, I can make a slightly different case for the current environment in that the eight week VIX spike that topped out at 81.17 was so severe and persistent that it is not so much the extreme fear that is important from a trading perspective, but an indication that a diminution of that fear is taking place. In many places in this country, people have not been this fearful in 75 years, so any indication that fear may be starting to reverse direction is indeed significant.

Let’s see where we are in three weeks…

[source: StockCharts]

Monday, October 20, 2008

The VIX in the Context of Historical Volatility of the SPX

The chart below uses the same data (7/1 - 10/17/08) as the chart from the previous post , but adds the VIX to the mix to make it easy to see where the VIX has ranged relative to the historical volatility of the SPX for the past few months.

[source: VIX and More]

SPX Historical Volatility Snapshot

Adam at Daily Options Report had a post up over the weekend in which he explained why he has lately preferred 10 day historical volatility to 30 day volatility.

Given that I track a lot of historical volatility data, I thought it might be interesting to post a graphic showing historical volatility as calculated (essentially as the standard deviation of the log of returns) over a variety of rolling lookback periods ranging from 10-100 days. The results show a steady increase in historical volatility over the course of the past two months that is unprecedented during the course of the past two decades. Even in 1987, volatility did not continue to rise for such a long period.

With the VIX near 70 at I type this, it is tracking most closely to the 30 day historical volatility at the moment. Going forward, I will have much more to say about historical volatility, implied volatility, and the interplay between these two measures.

[source: VIX and More]

Friday, October 17, 2008

VIX Closes Over 70 for First Time (70.33)

The VIX managed to tick above the 70 mark in the last minute of trading today to surpass last Friday's record close of 69.95. The volatility index had spend all of the last three hours of trading below the previous record, but jumped higher after the equity market closed and just as index options trading was winding down at 4:15 p.m. ET.

The VIX's intra-day high of 74.48 never challenged yesterday's record of 81.17, but the spike at the close suggests that investors continue to remain skittish about weekend headline risk. Warren Buffet may be saying "be greedy when others are fearful," but for many, this is easier said than done.

TED Spread and VIX Both Coming Back to Earth?

It remains to be seen whether yesterday’s new high of 81.17 in the VIX turns out to be the top in that index. Personally, I think there is a good possibility that 81.17 holds up for many years, but I also believe that it is even more likely that the TED spread (which measures the difference between LIBOR rates and the yield on the 3 month U.S. T-Bill) high of last Friday will mark the maximum point of atherosclerosis in the credit markets.

In the graphic below, courtesy of Bloomberg, you can see that the TED spread has already pulled back about 14% from the October 10th high.

Even a slow thaw in the credit markets and in equity volatility should be a sign that the global economy is turning the corner. In fear and panic there is opportunity; and as we turn the corner, the opportunities are greatest.

[source: Bloomberg]

Thursday, October 16, 2008

VIX:VXV to 1.51

There is no such thing as a guaranteed bottom, but there is a high probability that we just confirmed a bottom...depending, of course, on the volume of hedge fund liquidations still to come

Support Broached in NDX

Other major indices continue to hold above Friday's lows

Welcome to the 80s: VIX at 81.17

...and the Oct 100 calls now at 1.40 - 1.60

VIX Spikes to Record of 77.72 relatively orderly selling. The VIX just surpassed the previous all-time high of 76.92, which was set last Friday.

Also of interest, Oct 100 calls just traded at 1.00

VIX Oct 100 Calls: Bid 0.55 - Ask 0.95

The Oct 90 calls are 1.00 -1.40

Wednesday, October 15, 2008

Second Highest VIX Close Ever: 69.25

The VIX spiked to 69.47 at 4:07 p.m. ET, just a few minutes after the equity markets closed (the VIX is calculated up until 4:15 p.m. ET, when index options trading ends) and settled at 69.25 for the day.

This makes today the second highest close ever for the VIX, behind the 69.95 from last Friday.

To put things into perspective:

  • the VIX's 10 day moving average is now 56.69

  • the VIX October futures settled today at 58.00

VIX Spikes to 66.25

Many market sentiment indicators at extremes again, suggesting strong possibility of a reversal

Excellent Summary of Financial Crisis at Freakonomics

I normally shy away from devoting a post entirely to heaping praise at one particular post out in the blogosphere, but Steven Levitt's (of Freakonomics fame) Everything You Need to Know About the Financial Crisis: A Guest Post by Diamond and Kashyap is required reading for anyone who wants an excellent summary of where we are, how we got here, and what might happen going forward

Could Today Be a Higher Low?

Don't be surprised if that turns out to be the case...

Implied Volatility Over 150 in EWZ, the Brazil ETF

Truth be told, I could pick a ticker at random and have a compelling chart of implied volatility. Some, of course, are more compelling than others.

Take EWZ, for instance, the Brazil ETF. This resource-rich country has seen its ETF lose more than half of its value over the past year, coupled with a dramatic rise in volatility over the course of the past month.

In the chart below, courtesy of the International Securities Exchange, one can discern that implied volatility and historical volatility had been hovering in the range of 40 even as the ETF trended down during the summer. Starting in early September, the increase in volume in both the ETF and the options hints than an even wilder ride is coming.

In fact, implied volatility spiked from 40 to over 140, with historical volatility making similar gains. At the moment, both mean IV and HV are over 120, with both the near the money calls and puts expiring at the end of the week showing implied volatility readings in excess of 150. This is country risk at extreme levels.

Those with a directional preference who are looking to limit risk in high volatility environments may wish to look at bear call spreads for a short bias and bull put spreads for a long bias.

[source: International Securities Exchange]

[Disclosure: long EWZ at time of writing]

Tuesday, October 14, 2008

Yesterday’s VIX Drop Is Fifth Largest Ever in Percentage Terms

Yesterday the VIX registered its largest one day point drop in history, falling 14.96 points, but what does that mean?

If history is any guide, the drop in the VIX may not be particularly meaningful. The previous largest drop in the VIX in absolute numbers dates back to September 1, 1998. On that day, there was a brief lull in the Long-Term Capital Management crisis and the VIX pulled back from 44.28 to 36.48. Just three days later, however, the VIX was back above 44.

In percentage terms, yesterday’s 21.4% drop in the VIX is the fifth largest one day drop in the VIX in 19 years.

I wrote about previous instances of 20% drops in the VIX a little over a year ago in On the Rarity of a 20% One Day Drop in the VIX. Since that post, the VIX dropped 22.5% on 11/13/07 and exactly 20% on 3/18/08.

In the six previous instances in which the VIX has dropped at least 20%, the SPX has generally underperformed the historical averages slightly going forward.

Maybe someday I should publish the Guinness Book of Volatility Records…

Monday, October 13, 2008

DJIA +573 Today; VIX at 61.43

Someday this will look like a very strange headline, but right now it makes perfect sense...

Institutional Interest High in These Nine Large Caps

Stocks of all sizes and shapes are trading up today, but which ones will continue to do well if the market holds up?

In the graphic to the right (courtesy of Yahoo) I highlight nine large cap stocks that appear to be the biggest targets of institutional interest not just today, but when the markets moved up in spurts last week too. Those that made the cut did so on the basis of several price factors and several volume factors. The list consists of five technology names (MSFT, AAPL, RIMM, ORCL, and DELL), two mining/metals stocks (RIO, FCX), and two energy stocks (PBR and CHK). Interestingly, two of the nine companies are based in Brazil.

At the very moment at least, these nine companies look to be at the top of the heap: quality stocks at attractive valuations, with considerable institutional interest. I would expect these names to continue to lead the way in subsequent bull moves.

Note that one company on this list may be somewhat of a special case. Chesapeake Energy (CHK) CEO Aubrey McClendon was forced to sell “substantially all” of his 33 million shares last week to meet a margin call. With that forced selling completed, the stock is bouncing back today.

Friday, October 10, 2008

Two More VIX Records

Once again, the VIX is in the record books, with two new highs:

  • new closing high: 69.95
  • new intra-day high: 76.94

Of course, today is also the first time the VIX traded over 70.

In other volatility index news, the VXO (CBOE S&P 100 Volatility Index) closed at 86.14, almost exactly half of the all-time record high of 172.79 from October 20, 1987. The VXO had an intra-day high of 103.18, marking the first time the 'original VIX' has been over the 100 mark since 1987.

VIX November Futures

Per reader request, a chart of the VIX November futures (X8), courtesy of

[source: FutureSource]

VIX to 70.56 as Markets Start to Snap Back

How long this snap back will last remains to be seen, but there is a strong possibility that we just made an intermediate bottom

OHFDEX One Year Later

One year ago, in “From Overripe to Vulnerable?” I introduced something I called the OHFdex or listing of Overripe High Fliers, along with 14 CandleGlance charts from for the highest fliers.

Needless to say, the picture one year later is an ugly one.

Not only were these stocks overripe and vulnerable a year ago, but they were ripe for decimation. CROCS (CROX) is down over 97% in a year, Las Vegas Sands (LVS) is down 90%, and both DryShips (DRYS) and VMware (VMW) are down more than 80%. All told, 11 of the 14 former high fliers are down 50% or more. The mean decline was 67.7% and the median decline was 69.3%. The best performer among the group was Baidu (BIDU), the Chinese search engine company, which has lost 36% while the Chinese markets have fallen 57%.

I have also included one year charts (once again courtesy of for all 14 members of the OHFdex below, with a 20 day SMA in blue and a 50 day SMA in red:

[source: StockCharts]

Sifting among the rubble of today’s meltdown, it looks as if it is about time to create a new list of oversold stocks that can prosper over the course of the next year.

Thursday, October 9, 2008

New Record Close for Volatility Indices

Today’s dramatic last hour selloff resulted in new record high closes in four of the seven major U.S. volatility indices, including the VIX, which exceeded 60 for the first time and established a new record close of 63.92. In addition to the VIX, the VXD (CBOE DJIA Volatility Index) and the RVX (CBOE Russell 2000 Volatility Index) also set new records.

Note that these volatility indices have different life spans and data histories, so the comparisons of all-time record highs across indices are not always particularly relevant. For more information on all of the volatility indices, try Overview of U.S. Volatility Indices.

Feels Like Capitulation to Me

Not that it cannot get worse, just the I think we stop here for now...

VIX October 80 Calls Quoted 0.40-0.55

These are a new contract as of today and already have a volume of 1320...

VIX Hits 60

No sign of capitulation yet...

Capitulation Leg?

The sharp move down just after 3:00 p.m. EDT has some elements of a capitulation move.

Failure to Launch

Almost all of my overbought and oversold indicators that I apply to various indices and ETFs are screaming “oversold!” at the moment. One index in particular, the S&P 400 MidCap Index, stands out among the crowd. The MidCap Index, which has an ETF that trades under the ticker MDY, has been in existence since 1995. The chart below, courtesy of Yahoo, shows the performance of that index over the past 15 years. If you are looking for an overbought/oversold indicator, the 21 day rate of change (ROC) indicator is a good one. Looking at the ROC for 2008, notice how the current readings are the third time this year that the ROC set a new record for negative ROC. Also, the current reading of -33.95 is more than double what had been seen prior to this year.

With all of the oversold extremes, there will certainly be at least a short-term bounce soon. The fact that it has not happened yet is particularly interesting and means that more rocket fuel is building up for that bounce. For now, however, the failure to launch says as much about the investor psyche as anything else. Only in a market with a VIX approaching 60, would a market be too fearful to bounce.

Sometimes it is what the markets don't do that speaks volumes...

[source: Yahoo]

Wednesday, October 8, 2008

VIX Sets Third Consecutive End of Day High

The new end of day mark is 57.53...and the official new intra-day VIX high is 59.06

For reference, the all-time high close as of two weeks ago was 45.74, making today's record a 26% increase.

VIX October 70 Calls Last Traded at $0.50

Below I have attached a snapshot of the VIX October options, courtesy of optionsXpress, just as the VIX was making a new all-time high of 58.92. There are some amazing numbers in this table, which I am capturing here for archival purposes.

[source: StockCharts]

Yet Another VIX Record: 58.36

The VIX spike to 58.36 seem to trigger a little buying on weakness.

At this point, one of the more important trends to watch is the relative levels of buying on weakness vs. selling into strength.

A Conceptual Framework for Volatility Events

I developed a framework to aid in thinking about volatility events awhile back and given the recent volatility, I thought it might be helpful to share that framework.

First, there are many different types of events that affect volatility. Some of these events transpire almost instantaneously according to an exact timetable that is known in advance, even if the facts are a surprise. Examples of exact-instantaneous volatility events include government economic data (e.g., tomorrow’s weekly jobless claims), corporate earnings announcements (e.g., Chevron (CVX) reports tomorrow), and yesterday's speech by Ben Bernanke. Other events unfold incrementally on a fuzzy timetable, with any number of twists and turns. Examples of fuzzy-incremental events include hurricanes (Gustav, Hanna, etc.), geopolitical crises (Georgia/South Ossetia, Iran, Iraq, etc.), and of course, the current financial crisis.

Contagion is an important aspect of volatility events. Will the event spread and trigger other related high volatility events? Sector contagion (institutional interconnectedness in the financial sector) and geographical contagion (the Asian financial crisis) are relatively common, but entity-specific problems (e.g., Enron) generally do not spread to encompass an entire sector (though they might hint at a broader previously unrecognized sector problem.)

Without diving into too much detail in this space, I will mention two other related elements of a conceptual framework for volatility events: recurrence and reversibility. Government data reports are recurring and reversible. Productivity and GDP numbers are released quarterly and are subsequently revised. FOMC announcements and same store sales numbers are recurring, but are not revised. Fuzzy-incremental volatility events are not recurring (in identical form) and are not reversible. Legal rulings, however, are not recurring and are reversible.

So what does this all mean? It means that most volatility events can be classified along five dimensions and those dimensions can be used to predict the magnitude of the impact that a specific event type will have on volatility.

In the graphic below, I have distilled the above into five dimensions and have provided a framework for thinking about how they impact volatility. A high volatility event would therefore generally have little advance notice (note the “Low” designation at the top of the arrow, meaning that a low level of the element translates into high volatility), have a long duration, involve a high degree of (or potential for) contagion, not be recurring, and not be reversible. Also, the contagion element normally has a greater impact on volatility than advance notice, which tends to be a more important volatility factor than reversibility, etc.

[source: VIX and More]

As always, feedback is encouraged.

Tuesday, October 7, 2008

Another VIX Record Close: 53.68

The VIX handily surpassed yesterday's record close of 52.05 by establishing a new mark of 53.68 today.

For most of today's session, yesterday's VIX record looked safe, until a flurry of selling in the last half hour lifted the VIX to a new end of day high. Today is the third record close for the VIX in the last seven sessions. Also of interest, today's intra-day high of 54.19 was the second highest on record, behind yesterday's 58.24 mark.

One bit of obscure VIX trivia: today the VIX closed 116% above the 100 day moving average of 24.87, yet another VIX record.

As a reminder, VIX calculations continue until 4:15 p.m. ET, which is when trading ends for the underlying SPX options.

XLF Equals Mid-July Low

The all-time low for XLF was 16.61 back in July. XLF, the closely-watched financial ETF, just touced this low as I type this, following the report of a pending U.K. bank bailout/rescue plan.

VXO Chart from 1987-1988 and Explanation of VIX vs. VXO

In the past, I have gone to some length to differentiate between the VIX and the VXO, but given all the confusion I have seen in the media over new VIX records, I think it is time to offer up some history that may help clarify the situation.

A good place to start, frankly, is with a prior post that I titled Ten Things Everyone Should Know About the VIX. For the visual learners out there, I have reduced the history of the VIX and the VXO to a graphical timeline below. Here are some of the important facts in a nutshell:

  • The VIX was launched in 1993
  • In September 2003 the formula used to calculate the VIX was modified substantially
  • Data from the new 2003 VIX formula has been assigned the VIX ticker, but the CBOE published a reconstruction of historical data for the new VIX formulation going back to 1990
  • At the same time, the data (both historical and subsequent) associated with the ‘original VIX’ formula was assigned a new VXO ticker

The result is that for all practical purposes when you or your data provider refer to the VIX, this means the new 2003 VIX calculation and the historical reconstruction of the data for the new VIX formula. Similarly, the VXO ticker refers to VXO data from 2003 to the present, ‘original VIX’ data from 1993 to 2003, and a historical reconstruction of ‘original VIX’ data that goes back to 1986.

[source: VIX and More]

So, in terms of record-keeping, there was no VIX or VXO in 1987, but a historical reconstruction of the VXO arrives at an intra-day high of 152.48 and closing value of 150.19 for Black Monday, October 19, 1987 as well as an all-time high intra-day VXO of 172.79 for October 20, 1987. The chart below details the action in the historical reconstruction of the VXO for the period from October 1987 to March 1988, when the VXO finally slid back below 30.

[source: Yahoo, VIX and More]

Monday, October 6, 2008

Two Bond Blogs to Read

I joke about being "Your one stop VIX-centric view of the universe," but since that's what draws most of my readership to this site, I am happy to oblige by focusing on volatility and the equities markets.

On the credit markets side of the fear and anxiety equation, I give that subject less treatment here than it probably deserves (though it gets more attention in my newsletter.) Part of the reason for this is the two bond blogs I read religiously that do an excellent job of covering the debt universe:

I highly recommend that you check these two blogs out and make them part of your daily reading.

VIX Over 56; Expect Snap Back Soon

I suspect the current level of panic is nearing a climax

VIX Sets New Record of 50.75

Given market conditions, the levels of the VIX continue to suggest an orderly selloff, with the VIX still being held back by a strong gravitational pull.

If the DJIA fails to hold the psychologically important 10,000 level, we might see more in the way of anxiety.

Genuine panic should put 55 and perhaps 60 in play very quickly.

VIX Expected to Open at 53-54

There are still 25 minutes before the markets open for today, but based on the futures, the day of the week and other factors, it looks like the VIX will break the 50 mark for the first time ever at the open. At this point, I am estimating a VIX in the 53-54 range at the open. This would break the previous VIX record of 49.53 set during the Long-Term Capital Management crisis.

Friday, October 3, 2008

Environmental Factors and Chart Reading

I happen to think that charts provide important clues to the behavior of participants in the various financial markets.

Of course there are many ways to read a stock chart and consequently it can be more of an art than a science, so when I see some related scientific studies, I tend to take note of their conclusions. One example is Do You Want to Believe? which appeared today in Science and discusses an experiment in which subjects had varying degrees of control over their situation and were tested on how likely they were to see imaginary images embedded in snowy pictures

Jennifer Whitson, one of the authors of the report, describes the findings as follows:

“People see false patterns in all types of data, imagining trends in stock markets, seeing faces in static, and detecting conspiracies between acquaintances. This suggests that lacking control leads to a visceral need for order – even imaginary order.”

The bottom line: if your investments have been faring poorly lately and you have had trouble reading the trends, make an effort not to be overly reliant on charts – or at least make sure to use a consistent quantitatively-based approach to analyzing those charts.

Thursday, October 2, 2008

S&P 500 Index Sets New Volatility Record for Fourth Consecutive Day

When measuring volatility, there is a tendency to focus on historical volatility and implied volatility as the appropriate yardsticks. One looks backward and is a statistical calculation; the other looks forward and lets market participants estimate future volatility.

The VIX gets the bulk of the press, but as a measure of implied volatility, it tells you nothing about what has just happened.

Don Fishback and Adam Warner (Daily Options Report) have opined that historical volatility can be as useful in measuring volatility as implied volatility.

Depending on one’s purpose, I am inclined to agree. In fact, in addition to implied volatility and historical volatility (which is simply the standard deviation of the log of returns of a period of X days), I am a big fan of Average True Range, which is also known simply as ATR.

Developed by J. Welles Wilder and first made public in the classic New Concepts in Technical Trading Systems, ATR first calculates true range as the maximum of:

  1. the difference between today’s high and low;
  2. the difference between today’s high and the previous close;
  3. the difference between today’s low and the previous close.

Average true range is simply the true range averaged over a standard lookback period (most often 14 days), traditionally using an exponential moving average, but sometimes using a simple moving average.

Now for the punch line, which is probably a couple of paragraphs too late: in each of the past four days, the S&P 500 index (SPX) has set new all-time highs in its 30 day historical volatility reading, as well as the simple moving average version of ATR. Further, if you normalize ATR by dividing it by the daily close of the SPX, the past four days have also seen new all-time highs in the normalized ATR.

So…the VIX may be pulling back a little, but backward looking measures of volatility such as historical volatility and ATR are continuing to establish new all-time highs.

Further reading:

Wednesday, October 1, 2008

A Week in the Life of VIX Calls

Last week I talked a little bit about VIX Options as Catastrophe Insurance and talked about how VIX options are priced off of VIX futures, not the cash/spot VIX index that is quoted in the press. A lot can happen in a week.

In the graphic below, I compare VIX October calls for selected strikes from 10 to 60 as they were quoted (using the midpoint of the bid and ask) at about 2:30 p.m. EDT on September 22nd and again after the market closed on September 29th.

During the course of the week, the VIX jumped from 31.74 to 46.72, a 14.98 point gain or 47% increase. As you can see, even the deep in the money VIX calls (i.e., the 10 and 15 strikes) failed to move even half as much in absolute terms as the cash VIX. The 30 strike, which was below the cash VIX prior to the spike, only moved about ¼ as much as the cash VIX. Looking out to the 45 strike, those VIX options gained all of 0.75, or about 5% as much as the cash VIX moved during the week.

For the record, from September 22 to September 29, the VIX October futures advanced approximately 21%, from a little over 25 to a little over 31.

I will have much more to say about the behavior of VIX options and futures, particularly in and around the September 29 VIX spike, going forward.

[NOTE: The grayed out numbers means there was no bid, so the calculation above is half of the ask]

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