Saturday, January 31, 2009

Chart of the Week: Industrial Production in Japan

With all the hoopla over a 3.8% drop in Q4 GDP in the United States and a 2.0% decline in industrial production reported two weeks ago, this seems like a good time to remind my largely Americentric audience that things are much worse overseas, particularly in Asia.

During the week Japan reported that December industrial production fell 9.6% and South Korea reported a December decline of 18.6%. These are staggering numbers, whether one chooses to compare them to U.S. data or to historical data sets.

In this week’s chart of the week, I have elected to compare Japanese industrial production data from December 2003 to December 2008, partly because I like the look of the Japanese characters and partly because it illustrates just how dramatically Japan’s export economy declined during the last three months of 2008.

Rapidly declining industrial production may well be Asia’s next major export to the U.S.

[source: Ministry of Economy, Trade and Industry - Japan]

Friday, January 30, 2009

First Day of Trading in VXX and VXZ a Success

The first day of trading in the VIX ETNs was an unqualified success. Volume in the iPath S&P 500 VIX Short-Term Futures (1 month) ETN (VXX) hit 215,700 shares, while its 5 month counterpart, (VXZ), traded 73,900 shares.

To put these numbers in perspective, on the first day the Direxion triple ETFs were traded (in early November 2008), they registered volumes of 19,063 (BGU), 30,783 (TNA) and 10,313 (FAS). Less than three months later the least popular of the three ETFs is now consistently trading more than 10 million shares per day.

While predicting success for the Direxion ETFs looked like a no-brainer for me, the idiosyncrasies of the VIX and the VIX ETNs means that it is more difficult to guarantee superstar status for today’s new market entrants, even if they had a more impressive opening day. It may take a while, for instance, for investors to decide whether the new VIX ETNs are best suited to day trading, pairs trading, hedging, arbitrage or other strategies, but clearly VXX and VXZ have the potential to be in the top tier of the ETF/ETN trading vehicles.

In terms of relative price movement, the chart below highlights the differences between the most volatile cash/spot VIX (black line), the less volatile VXX (gold line), and the comparatively sluggish VXZ (blue line). At different times during the day, VXX moved at about 50-80% of the rate of the VIX. Not surprisingly, the longer-term sibling, VXZ, captured the overall upward trend in volatility, but was reluctant to reverse direction.

It is always difficult to draw meaningful conclusions from one day of data, but now that there are finally some VIX ETN data points to talk about, at least we can begin to extrapolate in the direction of a statistically significant universe.

[source: BigCharts]

First Comparison of VIX and VXX Movement

It will take several days before there is sufficient data to draw a meaningful comparison between the VIX and VXX, the new VIX ETN. For better or for worse, that will not prevent me from commenting on how VXX looks coming out of the starting blocks.

My first observation is on the volume. With 143,600 shares being traded in the first three hours since VXX was launched, it looks as if this product is going to be a hit with investors. Not only is the volume high, but it has been reasonably steady too, with a few spikes along the way.

In terms of how closely VXX tracks the VIX, the one minute chart below (top) from BigCharts provides the first graphical depiction of the relationship between the two. On average, VXX (black line) has been a little less volatile than the VIX (gold line), but there have been periods when the VXX has moved more decisively than the VIX.

I have added a five minute chart (bottom) to smooth out some of the noise inherent in a one minute chart. The trends and relative movements are easier for the eye to digest in this chart and demonstrate that VXX has been significantly less volatile than the VIX in the first three hours of today’s session.

Absent any statistical analysis (coming next week), I would say that so far as today’s data indicates, VXX is an excellent though slightly sluggish (as expected) proxy for the VIX. All things considered, it is already the best trading vehicle for approximating the cash/spot VIX that has been brought to market.

[source: BigCharts]

Disclosure: Long VXX at time of writing.

VXX Is Trading; No Sign of VXY Yet

Of the two new VIX ETNs, I see that VXX is trading this morning, but I have not seen any activity in VXY, perhaps because it is not yet trading. [Edit: a commenter noted that the correct ticker for the 5 month VIX ETN is VXZ, not VXY]

VXX opened at 100.11 and is currently trading at 101.49.

Some brokers are picking up the VXX ticker today and some appear to not yet have it in their system. The graphic below is from optionsXpress. The NYSE and Yahoo Finance are among those web sites that already have VXX information available.

[source: optionsXpress]

Thursday, January 29, 2009

Spot VIX vs. VIX Five Month Futures

Tuesday I went the analogy route in Thinking About the New VIX ETNs. Today I thought I should try the direct route and show a graph of the difference between the cash/spot VIX and the VIX futures five months out.

Keep in mind that the Barclays VIX ETNs, which are scheduled to begin trading tomorrow, target constant weighted average futures maturities of one month (VXX) and five months (VXY). The methodology used to achieve the constant maturity involves the blending of different proportions of various futures maturities each day. The chart below is slightly different in that it utilizes VIX futures with five months to maturity, but only rolls the contract out once per month. Nevertheless, it provides a very good approximation of the difference between the cash/spot VIX and the VIX futures with five months to maturity. Apart from confirming the large difference between current volatility expectations and expectations 5 month out, the peaks and particularly the valleys in the differential between the VIX and VIX five month futures show a high degree of correlation to the peaks and valleys in the SPX during the same period.

Something to think about, anyway, as the VIX ETNs near the starting gate.

And yes, these principles are similar to what I have talked about at some length with respect to the VIX:VXV ratio. For the record, the VIX:VXV ratio sits at 0.976 as I type this, slightly bearish, but consistent with the tight range this ratio has been in over the course of the past month.


For some additional perspective on the new VIX ETNs, check out:

…and for those who may have missed it, I published some initial thoughts on VIX ETNs from the top bloggers over the weekend in Barclays VIX ETNs Slated to Begin Trading on Friday.

Wednesday, January 28, 2009

Positive News in Housing Inventories

I have been maintaining for a long time (particularly in the subscriber newsletter), that the key to the bottoming process in the economy is housing and the key to housing prices is inventory.

While housing prices continue to fall, yesterday was the first glimpse of hope on the inventory front in a long time. In the graphic below, I have captured the months of supply of housing inventory since 1963. Note that the December data show the biggest drop in housing inventories in 28 years.

Before anyone gets too excited about this development, however, a couple of caveats are in order. Considering that months of supply is a function of total inventory and the transaction rate, there are several moving parts in these calculations. The fact that housing inventory is still at levels comparable to what was seen in early 2004 means that in absolute terms, there is still a room for considerable improvement before the inventory issue is addressed. Further, in some parts of the country the majority of the transactions are related to foreclosure activity. Given the high elasticity of foreclosure sales, this component of the transaction rate has to be taken with a very large grain of salt.

The economy has likely not yet reached a bottom, but there are encouraging signs. If housing inventory continues to fall and cash starts departing money market funds in search of better returns, then it is possible to at least entertain the possibility that equities have turned the corner.

[source: Census Bureau, VIX and More]

Tuesday, January 27, 2009

Thinking About the New VIX ETNs

Last night I was contemplating how traders who are unfamiliar with futures should think about the forthcoming VIX ETNs relative to the VIX index that many are already (somewhat) comfortable with.

Since the VIX ETNs are based on VIX futures with constant maturities of one month and five months, it is important that an understanding of these new volatility products be rooted in an appropriate concept of time. The first analogy that sprung to mind was that traders might consider the difficulty of guessing not just where a stock will be in another month, but where the 30 day moving average of that stock will be a month hence. Why? Because the 30 day moving average is smoothed and will not react as quickly to changes in the price as the underlying will, just like VIX futures vs. the VIX. (VIX Futures: The One Picture to Remember drives home this point in a succinct and memorable fashion.)

The more I think about it, however, the more the idea of moving averages as a proxy for futures movement may be one step too far removed from the VIX ETNs to bring some clarity to these new products. For that reason, I pulled together two graphs of the history of the VIX going back to 2007. In the top graph, I have a simple plot of the VIX (red) and the value of the VIX 21 trading days later (dotted blue). The key takeaway is that a lot can happen in 21 days. While the cash/spot VIX and the VIX front month futures rarely vary by more than 5%, investors might be surprised to learn that the difference between the VIX and the VIX +21 days was frequently as much as 30-50% (6-15 points per the gray line) during the relatively calm 2007. In 2008 we learned that the VIX was capable of moving more than 20 points in one month with surprising frequency, even getting 46 points out of line in late September.

The bottom chart adds the VIX +105 days to the mix. Most investors should consider that while their mind is anchored on the cash/spot VIX plotted in red, the reality is that in 21 and 105 days, almost anything can happen. That idea, along with a healthy understanding of mean reversion, should help the non-futures investor think about the new VIX ETNs.

[graphics: VIX and More]

Monday, January 26, 2009

Using Intraday VIX Reversals to Identify Market Reversals

I was going to wait for the market to pick a direction today and offer my thoughts on that direction, but since it looks as if indecision is becoming prevalent in the area of SPX 840-850, I thought it might be time to turn to a tangential subject.

Gio: The Hawaii Trader, has a post covering last week’s action with the title, Weekly Review: Using VIX Reversals to Spot Intraday Market Reversals…Over and Over and Over. As the title suggests, Gio claims that during periods of extreme market volatility the VIX often turns in advance of the broader markets and can therefore be used as a day trading tool. Unfortunately, at least to my eye, I find the accompanying chart provided by Gio to be inconclusive at best. To my (admittedly slightly astigmatic) eye, the DJI turns prior to the VIX in three or four of the five examples he cites.

More broadly, my own experience is that the VIX is a superb coincident indicator that occasionally lags turns in the SPX during periods of extreme market volatility – a phenomenon that I documented repeatedly during the last four months of 2008. My belief is that when the markets are falling rapidly and the VIX is spiking, investors frequently buy puts aggressively on the bounces, particularly when then fear the resumption of a bear trend. Very rarely have I witnessed the VIX turning before the SPX during periods of high volatility.

At some point in the future I will probably elaborate on this subject, but I would certainly be interested in hearing about the perspectives and experiences of other traders regarding the VIX as a day trading signal and as a leading or lagging indicator.

Sunday, January 25, 2009

Barclays VIX ETNs Slated to Begin Trading on Friday

Information pertaining to the two new VIX ETNs is hard to come by at this point, but Jamie Tyrrell’s (optionMONSTER) Volatility Sonar report from Friday indicates that a Barclays representative is talking about a launch this Friday, January 30th.

While I am not sure if the tickers have been finalized, I just now discovered an August 27, 2008 prospectus that describes the ETNs at some length and lists a VXX ticker for the iPath S&P 500 VIX Short-Term Futures ETN and a VXY ticker for the iPath S&P 500 VIX Mid-Term Futures ETN.

After I have had a chance to study the prospectus I will offer up more on these new ETNs.

In the meantime, some of the usual suspects have already offered some thoughts on the subject:

Saturday, January 24, 2009

Chart of the Week: Change of Trend in Cash Holdings?

Tempting though it may be to slap up yet another chart of the financials (XLF), bank index (BKX) or one of the individual bank that seems to be floundering even more than its peers, this is what I did with Bank of America (BAC) in last week’s chart of the week. The story has not changed much this week, except that the picture has become even uglier.

There may be a story developing, however, in terms of cash on the sidelines. According to data from the Investment Company Institute, cash in money market mutual funds jumped over 45% from August 2007 through last week, when it reached an all-time high. The chart below shows how cash on the sidelines has increased dramatically since last October, leaving less fuel to keep the S&P 500 index aloft. During the past week the ICI reported the first meaningful drop in money market mutual fund cash levels since September and also only the second time in 16 weeks that cash levels have dropped for institutional investors.

If the change in money market mutual fund levels from the past week is the first signs of a change in trend, then this will almost certainly have significant bullish implications for equities.

[source: Investment Company Institute, VIX and More]

Friday, January 23, 2009

Updated "Ten Things Everyone Should Know About the VIX"

For those who may be interested, I have just updated last April's Ten Things Everyone Should Know About the VIX, which was #1 on the list of Most Read Posts of 2008.

I will continue to update the "Ten Things..." post as appropriate going forward.

Four Horsemen of Technology Running Strong Again?

In this market, I find it hard to think of any stock as ‘running strong’ unless they are in the precious metals business, but strong can also be a relative term.

Some stocks have held up better than others – and even shown considerable buying interest – over the course of the past few weeks and months. Four which stand out from the past are the so-called Four Horsemen of Technology: Research in Motion (RIMM); Amazon (AMZN); Google (GOOG); and Apple (AAPL).

All four of these large cap tech generals have recently provided a positive earnings surprise, with the most recent surprise coming with Google yesterday afternoon. Had it not been for the Steve Jobs health issue, all four stocks would be crushing the S&P 500 index over the course of the past two months highlighted in the chart below. In fact, even with the Jobs issue, Apple is relatively even with the broad market index.

Investors are wondering which stocks will provide leadership in the next bull leg. My guess is that the next group of leaders will include one or more of these tech titans.

[source: BigCharts]

Disclosure: Long GOOG at time of writing.

Thursday, January 22, 2009

VIX (and VXN) After Hours

I recently received a question about large movements in the VIX at the end of the day.

Before I answer this question, it is important to recall that trading hours for index options are 9:30 a.m. – 4:15 p.m. ET.

As I see it, this question about late day movements in the VIX spans two very different time frames:

  • the last 15 minutes or so of the regular equities trading day (3:45 – 4:00 p.m. ET)
  • the 15 minutes following the close of trading of equities, during which stock index products are still traded (4:00 – 4:15 p.m. ET)

Looking at the earlier period first, during the last 15 minutes of regular trading on the NYSE and NASDAQ, high volume program trading often kicks in and includes or sometimes triggers a large volume of SPX options trades. These situations are relatively easy for retail trader to spot on the tape and are generally consistent with sharp moves in the SPX.

The fifteen minutes of index trading following the close of the equities market are more often associated with unusual large moves in the VIX. Part of the reason for this is the large volume of news that is announced just after the market close. Included in these announcements, of course, are earnings reports, such as today’s eagerly anticipated report from Google (GOOG).

In an announcement that crossed the wires at 4:01 p.m. ET, Google beat analyst estimates for both revenues and earnings, sending the stock up over 2% in the 15 minute twilight zone while index trading was still open.

Google is the second largest component of the NDX (NASDAQ-100), so the obvious place to see Google’s impact on the volatility indices is the VXN. The chart below, courtesy of thinkorswim, shows the VXN during the last 16 minutes of today’s regular equities trading session (using my local PT time stamp), as well as during the 4:00 – 4:15 end of the index trading session. The chart shows the positive surprise in Google helped to push VXN down 0.99 (2.1%) in the 15 minutes after the close of trading in the NYSE and NASDAQ regular session. Had Google beaten analyst expectations by a larger amount – or had a significant miss – I would not have been surprised to see the VXN move 5-10% during the twilight zone.

[source: thinkorswim]

Twenty Four Hours in the Life of the VIX Term Structure

When I last checked in on the VIX term structure, I used a graphic to show the changes in the term structure from the VIX peak on November 20th to the more complacent December 12th values. The results were dramatic and showed a drop of over 31 points in the front month volatility with the change falling off to just under 3 for the June 2010 SPX options.

Today I want to show what can happen in just 24 hours. Of course these were not your typical 24 hours, they were the first time the VIX has logged consecutive point changes of 10.00 or more: Tuesday the VIX gained 10.54; and yesterday the VIX lost 10.23 points.

The volatility dislocations resulting from yesterday’s market rally pushed the entire term structure down once again. In the chart below, I have highlighted the changes in implied volatility for SPX options for the first four months of the term structure. The one day change in February was 10.20 – almost the same as the drop in the cash/spot VIX. Looking out to March, implied volatility dropped 6.91. In April the drop was 5.33 and for May, IV dropped only 3.99. The smallest change was in the most distant month, December 2011, where implied volatility dropped only 1.04.

Even as volatility expectations have decreased in the last 24 hours, note that expectations for SPX IV for the end of the year are still in the area of 44 and do not drop below 40 until the middle of 2011. Volatility may be coming out of the markets, but according to options traders, the process will be a long and slow one.

[source: CBOE, VIX and More]

Wednesday, January 21, 2009

IndexUniverse Weighs in on Forthcoming VIX ETNs

Murray Coleman at IndexUniverse has an article up today that readers of VIX and More should find interesting: Pair of VIX-Tracking ETNs on the Way.

The bottom line is that Barclays Capital is looking to launch two VIX exchange traded notes:

  • iPath S&P 500 VIX Short-Term Futures (1 month)
  • iPath S&P 500 VIX Mid-Term Futures (5 months)
While the timing of the launch cannot be determined at this point, as I gather more information I will certainly have a lot to say about the informational content of these new products as well as some trading strategies.

2009 just got a lot more interesting.

What the VIX Thinks About Tuesday’s Breakdown

I know I shouldn’t be referring to the VIX as a sentient being, but I get so many questions along the lines of “what does the VIX think about…?” that I hope I can be excused for an occasional anthropomorphic slip of the keyboard.

In any event, I think the equity markets are at an important inflection point at the moment, with large commercial banks across the globe breaking down and starting to pull the major indices with them. Momentum is decidedly in the bearish camp and while today’s volume was of the fair to middling variety, we appear to be as close as one or two trading days away from the type of meltdown that could make November a fond memory.

Of course there are several possible scenarios and not all of them are bearish.

The chart below is one of my basic VIX charts and uses 10% and 20% moving average envelopes to bracket a 10 day simple moving average. The VIX closed 23.3% above the 10 day SMA, clearly at overbought levels, but as September and October showed, this is no guarantee we have hit a reversal point.

I also like to study the VIX relative to various historical volatility measures for the SPX. This too suggests an extremely extended VIX, with 10, 20 and 30 day historical volatility currently all residing in the 33-37 range.

The ever popular VIX:VXV ratio, which considers some elements that are analogous to the VIX term structure, is more neutral, with a slightly bullish reading of 1.032.

When I looked for historical data points that closely resemble the current situation I struggled to find analogous data. Only two periods come close to matching the present: October 2007, just when the markets were putting in a top; and July 1993, when the markets were slowly running out of steam, prior the bearish 1994 that preceded the great bullish leg from 1995-1999.

All things considered, my best guess is that the VIX is soon to begin suffering from oxygen deprivation and is not likely to climb much higher than the current altitude, providing some relief to the markets and keeping the SPX above the 770 level – perhaps even establishing 800 as the new SPX floor. The large pool of cash on the sidelines is sure to be tempted at current levels, but will not likely chase equities until there are some more convincing signs of a bottom forming. The next week or two could well determine whether the balance of the first half of 2009 is bullish or bearish.

[source: StockCharts]

Tuesday, January 20, 2009

Voodoo and Solvency, Krugman vs. Hempton

With talk of nationalization of European and American banks heating up, I want to make sure everyone had a chance to read Paul Krugman’s Wall Street Voodoo from Sunday’s New York Times. Krugman tackles the issue of so-called ‘zombie banks’ that can still operate while technically insolvent and whose market capitalization, says Krugman, “is entirely based on the hope that shareholders will be rescued by a government bailout.”

Krugman lays out three policy alternatives for addressing these zombie banks:

  1. sufficient government funds to support the operation of the existing entity
  2. seizure of the bank by the FDIC with a transfer of toxic assets to a third party (a ‘bad bank’ or ‘aggregator bank’ along the lines of the Resolution Trust Corp. model), followed by the resale of the now solvent bank
  3. transfer of toxic assets to a third party, without prior government seizure of the bank

The concern Krugman has is that the Obama administration is leaning toward the third alternative, which rewards bank shareholders at the expense of taxpayers and perpetuates the moral hazard problem.

John Hempton offers up a challenge to the zombie bank solvency question in Voodoo Maths and Dead Banks. Hempton claims that banks whose liabilities currently exceed assets can earn their way back to solvency if the net interest margin is sufficient to generate enough operating income to overcome the gap between liabilities and assets, hopefully in the span of a few years.

Hempton makes some excellent points and provides a philosophical foundation for much of the current approach. Given that there a lot of moving parts, the success of these efforts are ultimately going to be the result of several key factors, including:

  • the gap between liabilities and assets
  • the spread (net interest margin) banks will be able to realize going forward
  • the length of the economic contraction

From a government policy perspective, monetary policy will have a strong influence on bank spreads and fiscal policy will go a long way to determining the magnitude and length of the economic contraction.

Zombie banks can earn their way back to solvency in just the same manner that a homeowner who is underwater can continue to make mortgage payments until he or she crosses back into a positive equity situation in their home. The key for the banks is a healthy interest rate spread and a relatively brief recession that keeps loan losses from getting out of hand.

The problem with propping up zombie banks is that it may be too attractive of an alternative politically to prompt proper consideration of other options. Further, zombie banks will always look more attractive than they should due to the penchant for overly optimistic estimates of the gap between liabilities and assets as well as hopes morphing into beliefs that the economic downturn will be shorter than what the next pundit says.

Panic in the Air as VIX Hits 55.38

The last hour could get very ugly...

U.S. Banking Index More Bearish than November

With pressure on banks increasing across the globe and hitting European banks (RBS, AIB, BCS and DB) particularly hard, the U.S. banking sector now finds itself falling faster than it did even at the November lows. State Street Corp. (STT) has been considered one of the safest U.S. banks, yet announced today that profits in the most recent quarter fell 71%, largely as a result of a $6.3 billion loss in its investment portfolio during the quarter.

The chart below shows that the selloff in the banking index (BKX) is sharper now than it was at any time during the November bank panic. While the banking index and most of the large banks are making new lows, the S&P 500 index has managed to draw strength from other sectors to remain above the November lows and even above last week’s low.

The rest of the week should determine whether we have a higher low in the broader indices (my guess) or break below SPX 800 to challenge the November lows.

[source: BigCharts]

Financials Account for Half of Loss in S&P 500 Index in Past Month

While this should come as no surprise to anyone holding bank stocks, I find it interesting to note half of the losses in the S&P 500 index over the course of the past month can be attributed to the financial sector (XLF).

The chart below shows that while financials have fallen almost 21% during the last month, the other major industry sectors have come close to breaking even. Remove financials from the equation and only industrials (XLI) have lost 3% during this period.

The market is not healthy right now, but the collateral damage inflicted by financials on other sectors may have already peaked. This is not to say the market can rally without financials, but it is becoming increasingly difficult for the financial sector to drag the entire market down.

[source: AMEX, VIX and More]

Monday, January 19, 2009

Options Action Debuts, Looks Like Fast Money With Options Trades

Options Action is a new options-oriented show that made its debut on CNBC on Friday night at 11:30 ET. Hosted by Melissa Lee, the show is clearly an options derivative of Fast Money, from the format to the graphics to the audio.

Given the choice between targeting options-savvy viewers and a broader audience, CNBC has elected to aim for the generalist audience by emphasizing the news and issues, while including some recommended stock trades along with the options trades. If you have a casual interest in options, this show could help grow your knowledge base; if you already consider yourself to be a relatively sophisticated options trader, Options Action is not likely to have a great deal of appeal.

The format relies on current news and investment issues, with Melissa Lee keeping things moving by prompting the guests for some brief analysis and asking for recommended stock and options trades. Financials were the top story on Friday, with some debate about the plight of Wells Fargo (WFC). Steve Jobs and Apple (AAPL); crude oil; and Microsoft (MSFT) vs. Google (GOOG) were the other items on the agenda.

For a debut offering, I thought guests Joe Terranova, Stacey Gilbert, Jim Iurio, Mike Khouw and Brian Stutland did an excellent job of bringing a variety of perspectives to bear on each issue, with reasonably strong interplay among the group. My favorite part of the show centered around the discussion of a naked sale of Google June 300 puts for 43.00, as recommended by Stutland, or selling a put spread instead, as recommended by Gilbert.

In terms of options-specific material that you might not find on Fast Money, in addition to the proposed options trades, there was a quick blurb on unusual options volume at United Technologies (UTX) as well as several charts that showed five day options volume trends in some of the other featured companies. Other than that, the name of this program could easily have been Fast Money: Options Edition.

CNBC has Friday’s show archived in three parts for anyone who wants to see what they missed:

  • Part 1 -- Wells Fargo and the financials; Apple; crude oil
  • Part 2 -- Microsoft vs. Google
  • Part 3 -- Final trades: Apple, ConocoPhillips (COP), Microsoft, infrastructure plays

Saturday, January 17, 2009

Chart of the Week: Bank of America Teeters

It has been a tough week for the banks, but particularly for Bank of America (BAC), where the company’s recent struggles have earned it a stint in the spotlight as this week’s chart of the week.

During the week it was revealed that as a result of an ill-conceived acquisition of Merrill Lynch and other questionable moves, BAC extorted received secretive Treasury funding of $20 billion in addition to guarantees of up to $118 billion for toxic assets.

Bear Stearns and Lehman Brothers had their turn as the poster child for investor indignation, but now Ken Lewis and Bank of America are in danger of trumping some of the excesses of their ancestral whipping boys.

Either U.S. banks are about to reach a bottom…or we are witnessing the fall of the last few banks whose survival as independent entities might be able to prevent the wholesale nationalization of the banking system.

The monthly chart below shows not only the magnitude of the recent declines, but makes the case that in some respects, January has been the worst month yet, at least for Bank of America.

[source: StockCharts]

Friday, January 16, 2009

Can Bank of America Find Support at 7.50?

The 7.50 area provided some support for Bank of America (BAC) yesterday. As the stock continues to fall, I am beginning to wonder where today's support level will be.

BAC is right at 7.50 as I type this.

Can a BAC version of the LEHVIX be far away?

VIX January Options as Short-Term Portfolio Protection

I know that very few retail traders actively trade VIX options, but for those who usually do not consider this product, I want to highlight the fact that because the VIX expiration calendar is different from the standard third Friday of the month equity and index expiration calendar, this weekend might be an appropriate time to think about VIX options as a short-term portfolio protection play.

Anyone who has portfolio insurance in the form of options expiring tomorrow is likely concerned about what will happen over the long weekend, particularly with rumors about the possibility of Citigroup (C) and Bank of America (BAC) being nationalized. One solution, of course, is to roll those January options into February and beyond. If, however, you do not necessarily want to buy portfolio protection for a full month, then you can get it through Wednesday morning with the January VIX options. The last trading date for January VIX options is Tuesday, January 20th, with the options settled at the open on Wednesday morning.

Equity futures have been trending up over night, but substantial short-term risks remain, with all the uncertainty over the financials, compounded by a three day weekend, followed by the inauguration of Barack Obama coming up on Tuesday. I am not going so far as to recommend the purchase of VIX calls, but I do want to make sure that investors with a short-term horizon are aware of the VIX options expiration calendar anomaly.

[graphic: Options Industry Council]

Thursday, January 15, 2009

Good Chance SPX 821 May Be a Higher Low

It's way to early to know, but the odds are fairly good here for longs

Financials SPDR (XLF) Drops Below 10.00

XLF, the widely-followed financial sector ETF, dropped below 10.00 a few minutes ago for only the third day in its trading history.

Not only have financials been the weakest sector of 2009 so far, but their continued weakness will only raise more concerns about the structural integrity of the financial system.

Given the weakness in financials, I am surprised equities are not lower and VIX higher at this stage.

[source: International Securities Exchange]

Selling Naked Puts in Current Environment

During my recent trilogy on the put-write strategy, my intent was to identify an approach that performs well in a non-trending market. While I still believe we are stuck in a range defined by about 820-980 on the S&P 500 index, a strategy that involves selling puts generally performs at maximum levels toward the bottom of a well-defined trading range. In short, the current situation looks like an excellent time to write some cash-secured puts.

Several factors indicate that the timing for put sales may be ideal right now. With the VIX up over 51 once again as the market opens this morning and most measures of short-term historical volatility (such as the 10 day HV in the chart below) showing that the VIX is well above actual volatility we have experienced during the past few weeks, a likely conclusion is that volatility is overpriced at current levels. Further, with the SPX right at 830 as I type this, we are near the bottom of the trading range in the SPX, with significant support likely to be found in the 820-830 range.

Finally, the news flow has been so negative lately, from financials to retailers to Steve Jobs to global trade, etc. that a larger fear and anxiety component is starting to creep into implied volatility measures like the VIX.

For those looking to limit risk, cash-secured puts on indices or ETFs covering a group of stocks can help to eliminate single stock down side risk. Those who are interested in limiting risk from writing puts may prefer to look at a bull put spread, where the writer sells a put near the money and buys another out of the money put to limit losses.

[source: VIX and More]

Wednesday, January 14, 2009

VIX Tops 50 for First Time Since Mid-December

With the SPX failing to find support at 850 and financials falling another 6% this morning, the VIX has spiked all the way to 51.03, up 17.9% so far today and up 32.3% from just six sessions ago.

Since the large gap down at the open, today’s action has been more of a slow grind than a sharp panic, suggesting that there could be a fair distance still to the down side. SPX support may come in the 820-830 range, but if those levels fail to hold, the possibility of a drop back down to 740 suddenly looms large.

[source:  BigCharts]

Tuesday, January 13, 2009

Chris McKhann on VIX Options for Portfolio Insurance

A few weeks ago I discovered that I have an alter ego over at optionMONSTER who thinks about and writes daily about the same subjects VIX and More likes to tackle. I am speaking of Chris McKhann, whose How to Use VIX Options for Insurance, is available for those who do not mind going through the free registration process that is required to access all the free content at optionMONSTER.

Chris makes some important points about VIX options, notably that they are priced off of VIX futures. He adds that one can get a relative sense of the how expensive VIX options are by comparing the cash/spot VIX to the VIX futures. This approach is similar to using the VIX:VXV ratio and is something that I will discuss in this space in the near future.

(For a similar take I had back in September, check out VIX Options as Catastrophe Insurance.)

More on PUT Returns

Given the surprising interest in put-write strategies and the CBOE PutWrite Index (PUT), I have spent some additional time with the PUT data to see what sort of secrets I might be able to uncover.

I must confess that the more I dig, the more I am intrigued by this index put-write approach. Since there has been considerable discussion about the differences in return between the PUT and the closely related CBOE BuyWrite (BXM) Index, I will start by showing a table that has a year-by-year comparison of the PUT and the BXM. Just for fun I threw in the average VIX for each year, the change in the average VIX from year to year, the VIX range for the year and a ratio of that range divided by the average VIX. While none of these additional data points provides a smoking gun, each offers up a piece of the overall performance puzzle.

The second graphic is a simple matrix of monthly returns for the PUT since 1986. Not surprisingly, the two worst monthly returns were during the volatility peaks in October 1987 and October 2008. In a related note, several of the most profitable months for the PUT came just after high volatility events.

[Source: CBOE, VIX and More]

For those looking to dig deeper into this issue, consider that put-write absolute and relative returns are largely a function of implied volatility, the trending characteristics of the SPX and interest rates. Note also that that upper chart only goes back to June 1st, 1988 because that is when Standard & Poor’s began reporting daily dividends for the S&P 500 Total Return Index.

Monday, January 12, 2009

Graphical Comparison of Performance of PutWrite and BuyWrite Indices

I was pleased to see the strong response generated by Friday’s The Often Overlooked Put Writing Strategy, particularly in some of the comments at Seeking Alpha, where the post was republished. A number of questions came up regarding the reasons why two strategies that are synthetically equivalent (i.e. share the same profit and loss graph), would have different performance characteristics. I cited the main reason for the performance delta as the skew that results from a tendency to price puts higher than calls, particularly during times of extreme market stress, when demand for puts often exceeds the demand for calls.

I am not sure that I can prove beyond a reasonable doubt the skew hypothesis in this space, but I did assemble two performance graphs that might help to inform any further discussion. Using the CBOE PutWrite Index (PUT) and the CBOE BuyWrite Index (BXM) as my source data, I have plotted the two indices from their 1988 inception (above) and from 2002 (below), when the indices begin to substantially diverge.

From the two graphs, I find it interesting that the put-write strategy begins to generate separation from the buy-write strategy during the 2002-07 bull market. As volatility increases during 2007, the put-write strategy continues to widen the gap, with the recent bear market having very little impact on the performance differential between the strategies.

Those who have any thoughts on the reasons behind the performance differential during different market cycles, please feel free to chime in.

[source: CBOE, VIX and More]

Saturday, January 10, 2009

Chart of the Week: Volatility Drifts Lower

While stocks gave back some gains this week and any sense of inevitability was stricken from the consciousness of the bulls, volatility only grudgingly began to reappear on the charts.

In fact, if you look at the chart of the week below, you see more concern about future volatility in the form of the VIX than there are indications of rising current volatility, as reflected in the average true range (ATR) of the S&P 500 index. I elected to use the 21 day setting for the ATR, as it is based on trading days and approximates the 30 calendar day time horizon used by the VIX. For the record, shortening the ATR window to 10 days shows the same pattern of declining volatility. The SPX historical volatility picture is similarly calm, with 20 day historical volatility hovering around 31 at the moment.

Even with the markets selling off this week, volatility remains relatively low, at least as measured by post-Lehman standards.

[source: StockCharts]

Friday, January 9, 2009

The Often Overlooked Put Writing Strategy

Shame on me for going a year and a half without mentioning the CBOE S&P 500 PutWrite Index (PUT), a recipient of the Most Innovative Benchmark Index award at last year’s Super Bowl of Indexing Conference.

Given all the market volatility for the past three months or so, I suspect that a put writing strategy is probably not top of mind for most investors at the moment. In fact, a put write strategy like one tracked by the PutWrite Index will generally outperform the S&P 500 index in a down trending market and significantly outperform the S&P 500 index in a sideways market. Much like a covered call strategy, however, a put write approach will not match the gains of the underlying index in a strong bull market rally.

The CBOE describes the PutWrite Index methodology as follows:

“The PUT strategy is designed to sell a sequence of one-month, at-the-money, S&P 500 Index puts and invest cash at one- and three-month Treasury Bill rates. The number of puts sold varies from month to month, but is limited so that the amount held in Treasury Bills can finance the maximum possible loss from final settlement of the SPX puts.”
Additional information about the PutWrite Index is available at the CBOE PutWrite Index splash page.
I mention put write strategies for four reasons:
  1. If we continue in a non-trending market, as I expect we will, this is an excellent investment approach
  2. Ennis Knupp just published a superb analysis of the PutWrite Index: Evaluating the Performance Characteristics of the CBOE PutWrite Index
  3. Put write strategies have historically outperformed the more widely utilized buy write strategies
  4. Properly implemented, a put write strategy is not as risky as most investors expect
At a minimum, readers should check out the Ennis Knupp paper and get a better sense of the essence of put write strategies. Those who expect the markets to do anything other than rally significantly might also want to start implementing that strategy on their own.

Note that while there are currently no ETFs that utilize a put write strategy, it is a volatility strategy that is practiced by hedge funds.

Thursday, January 8, 2009

MarketSci Looks at the VIX 5% Rule

MarketSci is a blog that somehow manages to ponder the same sort of issues that I like to chew on. Fortunately, MarketSci does more than ponder. In fact, much like the approach favored by Quantifiable Edges, MarketSci seems to aspire to being the mythbusters of the investment world.

This week MarketSci has particularly interesting series of items on its plate: the Trading Markets 10 Trading Rules. One by one, MarketSci is taking a data-driven approach to determining the usefulness of each of the Trading Markets rules.

In today’s installment, Testing TM Rule #5: the VIX 5% Rule, MarketSci examines the popular TradingMarkets 5% rule that I discussed in 2007 in a post with the unlikely title of The TradingMarkets 5% VIX Rule. In short, MarketSci comes down on the side of the usefulness of the 5% rule as a defensive measure. The full analysis is worth clicking through for, as are the other installments in the analysis of the ten trading rules, most of which are consistent with my own thinking and several of which should probably be part of every trader’s arsenal.

Wednesday, January 7, 2009

Two Year Blogiversary

With all the excitement of the trading day, the VIX back up to 42.55 as I type this, and my share of technical issues (MyBlogLog, if would be nice if you could go back to tracking more than 20% of my traffic), I forgot that today is the two year anniversary of VIX and More.

Thanks to Adam Warner, Jim Kingsland, Barry Ritholtz and a host of others who offered their early encouragement back when I could count my visitors on my hands and toes.

For those who may be interested, the first post, VIX and More: An Introduction, still has some nuggets that are relevant for today’s market. My favorite post from that first month, however, is undoubtedly What My Dog Can Tell Us About Volatility.

Thanks to all who have made contributions of one kind or another to this effort over the course of the past two years.

Satyam, Fraud, and the India VIX

Today’s announcement that Satyam (SAY), the Indian outsourcing giant, has been engaged in a massive accounting fraud over the course of several years sent Satyam down 78% in local trading and dragged the Bombay Sensex down 7.3%.

All things considered, I was once again surprised by the relatively small spike in the India VIX, which jumped 14.5% to close at 44.36.

In the chart below I have plotted the course of the India VIX since November 2007 (the index launched in April 2008, but historical data has been reconstructed extending back another six months.) I find it interesting that the scale of the India VIX is not that much different than that of its U.S. counterpart. I also find it interesting that concerns about the global financial crisis in October 2008 was responsible for the peak in the volatility index, while the Mumbai terrorist attacks the following month barely register as a blip on the chart.

It remains to be seen what sort of long-term fallout the Satyam fraud will have on Indian equities, but so far the reaction has to be considered a relatively muted one.

Keep in mind that after many failed attempts at a bottom in 2001 and 2002, the NASDAQ did not put in a bottom until just after the WorldCom bankruptcy filing.

[source: National Stock Exchange of India, VIX and More]

Tuesday, January 6, 2009

On Volatility, Probabilities and Distributions

When I was in the process of publishing the winners of the 2008 Volatility Awards last week, I paused before finalizing Don Fishback’s Market Update as the recipient of the award for Best New Blog with a Volatility Focus. While there are many excellent blogs out there, my hesitation had nothing to do with the quality of Don’s site, which you should judge for yourself. Instead I wondered what would happen if hundreds of curious readers clicked over to the site and Don just happened to be taking a couple of weeks off for the holidays.

Well…Don is back and has a post up that is the early leader in the volatility post of the year category (should I decide to invent such a beast at some point.) Starting with the not-so-pity title of Probability, VIX, Bad Math, and Reporters Who Don’t Know the Difference: Measure, Don’t Model, Don Addresses some of the mathematical shortcomings of the Kearns and Tsang article, VIX Fails to Forecast S&P 500 Drop, Loses Followers and argues from the specific to the general case. For dessert, Don Serves up a nifty tool to help readers visualize the various probabilities and distributions associated with the VIX and the SPX.

Assuming the VIX does not spike back up to the 80s again, I will use this space to talk a lot more about probabilities and distributions in 2009 – and their application to the study of volatility.

Market Rewind on Risk

Since Joe Nocera, Michael Lewis and David Einhorn all had a chance to talk about risk in yesterday’s Required Reading segment, I thought it was timely of Jeff Pietsch at Market Rewind to pick this morning to offer up some of his thoughts on the subject of risk.

In ETF Risk in Review, Pietsch draws on data from his ETF Rewind tool to tackle the subject of risk-adjusted performance and ranks the 2008 performance of various ETFs within their grouping according to a Sortino Ratio (similar to the more familiar Sharpe Ratio, but the Sortino Ratio not penalize performance for upside volatility.) Not surprisingly, consumer staples (XLP) and health care (XLV) turn in the some of the best risk-adjusted performance numbers for 2008, while financials (XLF), emerging markets (EEM) and real estate (IYR) are notable laggards.

One key take away from the analysis is the value of thinking of ETFs in terms of miniature portfolios whose performance can be evaluated on a risk-adjusted basis. We witnessed history in 2008 and as painful as some of that history may have been to live through, hopefully we all enter 2009 with the benefit of a healthier and more sophisticated perspective on volatility and risk.

Monday, January 5, 2009

Required Reading: Nocera and Lewis/Einhorn in New York Times

In the event anyone missed them, I want to make sure I offer up a link to two excellent thought pieces from Sunday's New York Times. In no particular order:

  1. Joe Nocera’s superb Risk Management, an examination of Value at Risk (VaR) in Sunday’s New York Times Magazine. (Joe also blogs about a wide variety of business topics for the New York Times at Executive Suite.)

  2. Michael Lewis and David Einhorn's The End of the Financial World as We Know It

Direxion Triple ETFs Add New Horses to Stable

While skeptics abound about the usefulness of triple ETFs for the long-term investor, I have been saying since early on that the Direxion triple ETFs would revolutionize day trading.

Now that their novelty has worn thin and traders have had an opportunity to experiment with various approaches to trading triple ETFs, these vehicles have become an integral part of the day trading scene, particularly on trend days.

Looking to capitalize on the appeal of these nuclear-tipped trading weapons, Direxion added six new triple ETFs last month. While interest in the new round of ETFs has so far been limited, I predict at least one of the triple ETF pairs has a bright future. My candidates for stardom are the pair of emerging markets ETFs: the 3x bull (EDC) and the -3x bear (EDZ). The reason is simply a lack of competition. At the moment, competition comes in the form of EEV the -2x UltraShort MSCI Emerging Markets ETF from ProShares. While EEV is a popular double inverse ETF, it lacks a companion +2x version for those who want a leveraged bullish play on emerging markets without having to short EEV.

It is harder to see the other new ETF pairs attracting the same attention that the emerging markets are likely to receive. Technology is a favorite investment theme and a source of considerable volatility, but the current ROM (2x) and REW (-2x) have always been second tier ETFs in terms of popularity, lagging well behind QLD and QID, the popular NASDAQ-100 ETFs. The new Direxion entries, TYH (3x) and TYP (-3x) clearly have their work cut out for them.

Last but not least are a pair of ETFs based on the MSCI EAFE index of developed markets and the popular EFA ETF that tracks this index of European, Australasian and Far East companies. The 3x bull (DZK) and the -3x bear (DPK) have a lot of appeal to me as a means by which to speculate or hedge in non-U.S. companies, but whether these funds will receive the same kind of attention as EFA remains to be seen.

For the record, Direxion has outlined their intention to expand the stable of triple ETFs to 32 in their current prospectus. The ETFs currently in the pipeline have a strong international (China, India, Latin America, BRIC) and sector (clean energy, real estate, homebuilders) flavor. The graphic below shows the triple ETFs currently available, with the recent additions circled in red.

These ETFs are not for the faint of heart and anyone who considers trading these might want to read my initial post on the subject to get a sense of some of the risks involved.

[source: Direxion]

Sunday, January 4, 2009

The Year in Global Volatility (2008)

In November I launched the VIX and More Global Volatility Index, which is a weighted average of the implied volatility in options for equities in the 15 largest global economies. I will have more to say about the Global Volatility Index in 2009, but want to use this occasion to highlight the index as a means of tracking the rise of volatility in response to major volatility events during the course of the past year. In addition to the Global Volatility Index (shown in red), the chart below captures the Dow Jones World Stock Index (blue), as well as the signing of the TARP legislation (black) and the tickers (dark red) for some of the major financial companies that failed and/or were rescued by the U.S. government.

[source: VIX and More]

Subscriber Newsletter Now Available on Free Trial Basis

I do my best to keep subscriber newsletter information to a minimum on the blog, but I want to make sure readers are aware that I have made a number of enhancements to the subscriber newsletter. The most important change from a content perspective, is that instead of publishing two very different editions on Wednesday and Sunday, I am now combining all the content into one weekly issue, with new content.

Starting with today’s the newsletter, the Market Recap and Commentary section is being expanded into a more comprehensive The Week in Review and separate Market Commentary section. There will be an increased emphasis on a global perspective, macroeconomic issues and fundamental analysis.

Another new section, Volatility Update, tracks and analyze changes in the VIX, the VIX and More Global Volatility Index, the VXV, and a number of related indicators, such as moving averages in the VIX, historical volatility in the SPX, the VIX:VXV ratio, etc.

The new VIX and More Subscriber Newsletter will be published on Sunday evenings going forward, with the following ‘permanent’ sections:

  1. The Week in Review
  2. Market Commentary
  3. The Week Ahead: What to Look For
  4. Market Sentiment (using a proprietary Aggregate Market Sentiment Indicator)
  5. Volatility Update
  6. Asset Class Outlook (short, intermediate, and long-term outlook for ten asset classes)
  7. Weekly Feature(s)
  8. Current Investment Thesis
  9. VIX and More Focus Model Portfolios
  10. Stock of the Week
As the newsletter and the economy are undergoing some dramatic changes, I am now making the newsletter available on a free trial basis. In order to receive a free trial, just click on the “Monthly Subscription: Subscribe” button in the upper right hand corner of the subscriber newsletter and follow the instructions. The free trial lasts for 14 days. Readers who elect not to cancel after the 14 day trial period will be billed at a rate of $30 per month.

Also, as a gesture of appreciation to former subscribers, I will add one free month to any subscriber who chooses to re-subscribe.

In response to reader requests, I am also creating a detailed glossary to provide background on terms, abbreviations, acronyms and tickers I frequently refer to in the newsletter.

Thanks to everyone for all their suggestions and encouragement!

Saturday, January 3, 2009

Chart of the Week: ISM Plummets

The stock market may have shaken off the December ISM’s 32.4 number, but investors should keep in mind that in the 61 year history of the ISM index, only three previous recessions (1949, 1974-75 and 1980) have seen lower ISM numbers. Even more concerning than the headline manufacturing index number was the report that new orders are now lower than they have been at any time in the 60 year history of the data.

The chart of the week below captures in ISM and the SPX from 1950. In addition to the obvious cliff dive that began in September, I find it interesting that the manufacturing index has been slowly trending down since hitting a high in May 2004.

As an aside, in 2009 I intend to devote more space on the blog to macroeconomic issues (particularly housing, manufacturing and consumer spending), as well global events that shape the geopolitical and economic landscape.

[source: Institute for Supply Management, VIX and More]

Friday, January 2, 2009

Schaeffer and Connors: Two Veteran Perspectives on the VIX

While I wait to see if the VIX might find a new floor in the 30-35 range, I notice that two veteran VIX aficionados, Bernie Schaeffer and Larry Connors, are talking about their current views on the VIX.

Starting with Schaeffer, in Examining the Technicals of the CBOE Market Volatility Index (VIX), the veteran options strategist outlines several of the factors that are influencing his recent thinking on the VIX. Republished from a mid-December subscriber note, Schaeffer’s thinking includes:

  • Possible support at the ‘half high’ level of the VIX (50% of the November peak of 89.53)
  • The importance of round numbers (a VIX of 50)
  • Long-term moving averages (40 week and 80 week)
  • Sector correlation (especially commodities vs. financials)
  • VIX relative to SPX historical volatility (20 day HV)

David Penn, Editor in Chief at Connors’, weighed in earlier in the week with In Defense of the VIX, a response to a Bloomberg article by Jeff Kearns and Michael Tsang. Penn favors a relative VIX to an absolute VIX and cites the familiar Connors 5% rule, in which investors should be long the market when the VIX is 5% or more above its 10 day simple moving average and short when the VIX is 5% or more below the 10 day SMA. For those who are interested in learning more about the Connors approach, Short-Term Trading Strategies that Work has some interesting ideas and is a worthy successor to How Markets Really Work: A Quantitative Guide to Stock Market Behavior.

Thursday, January 1, 2009

2008 Volatility Awards

I thought I’d spare everyone a silly sounding name like “the VIXies,” so without further ado, here are the highly subjective and not-otherwise-nicknamed VIX and More volatility awards for 2008:

I’m sure I overlooked some other obvious awards. Feel free to add to this list in the comments section.

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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