Sunday, January 31, 2010

Chart of the Week: VXX Celebrates One Year of Futility

One year ago yesterday, the iPath S&P 500 VIX Short-Term Futures (1 month) ETN (VXX) was rolled out to little fanfare, with the exception of the widespread coverage that VXX and sibling VXZ received here when the ETNs were launched.

VXX opened at 100.11 that day, with the VIX at 42. 63. One year later, VXX is down 68.4% and the VIX is down 42.2%.

Setting aside leveraged ETFs, long positions in VXX were by far the best way to lose money in an ETF over the course of the last year. Putting the 68.4% loss in VXX in perspective, there were only two other ETFs in which investors could have lost 50% of their investment: short financials (SEF), which were down 52%; and short emerging markets (EUM), which fell 50%. Long natural gas (UNG) and short base metals (BOS) would both have resulted in losses of 48%.

This week’s chart of the week captures the VXX in all its futility, with a ratio of VXX to the VIX on top to see how VXX has underperformed the cash/spot volatility index throughout the past year.

The links below explain the manner in which negative roll yield and other factors have caused VXX to underperform the VIX and turn in such as disastrous performance. All things considered, I expect VXX to perform better relative to the VIX in its second year than it did in its first year, though admittedly this is not a very high bar to clear.

For more on how VXX is constructed and performs, readers are encouraged to check out:

[source: StockCharts]

Disclosures: short VXX at time of writing

Friday, January 29, 2010

SPX Pullback Now Second Largest Since March 2009

With today’s continued drop in the SPX (low of 1073.18 with 45 minutes left in the session), the index has now fallen 75 points from peak to trough. This is the second largest pullback in terms of points and percentage retracement since the March 2009 rally began.

The chart below updates the numbers for all eleven significant pullbacks in the last ten months.

Keep in mind that to match the 9.1% pullback of June-July 2009, the SPX would need to fall to 1045. The way the market is reacting negatively to what appears to be positive news, 1045 certainly cannot be ruled out.

Disclosures: none

Volatility Spotlight: InterOil (IOC)

The first individual stock I ever put under the volatility microscope on the blog was InterOil (IOC). The stock was trading just over 22 when I highlighted it back in July 2007, but what got my attention was that it had stratospheric implied volatility (IV) and historical volatility (HV) readings that were both above 150. “This is a keg of dynamite,” I proclaimed at the time, in what was probably an understatement. Within a month of my post, IOC traded as high as 42.00 and as low as 18.37 as speculation raged on the nature and extent of IOC’s oil and gas exploration efforts in Papua New Guinea. In 2008, the battle between bulls and bears continued in earnest with implied volatility in triple digits for most of the year and the financial crisis pushing the stock down as low as 8.90 after a pop to 41.62 earlier in the year.

The events of 2009 finally gave the bulls something to hang their hat on, as consecutive world record natural gas discoveries were logged and high profile investors such as George Soros and T. Boone Pickens took large positions in the company. With the story slowly unfolding, the stock ran all the way up to the 70s and made a high of 84.05 at the beginning of the current month.

As I write this the stock is now trading at about 62. With the lack of information coming out of Papua New Guinea, the stock continues to be a Rorschach test of sorts, trading on pure investor emotion and momentum a good deal of the time.

The chart below, courtesy of Livevol, captures two years of the stock price history (top chart, with 50 day moving average in red and 200 day moving average in purple), as well as two years of 20 day historical volatility (blue) and 30 day implied volatility (red). There are quite a few interesting data points on this chart. One that I find particularly interesting is that IV has remained relatively flat since June 2009, even though the stock tripled from that level. The last month or so has seen a steady uptick in both IV and HV, perhaps foreshadowing the recent 26% drop and perhaps indicating that even more fireworks lie ahead. Historically, IOC’s HV has had trouble topping its IV, but one big news item can change that picture in a hurry.

For more on related subjects, readers are encouraged to check out:

For those who want to get into some of the details of the IOC story, an excellent repository of information can be found at

[source: Livevol Pro]

Disclosures: Long IOC at time of writing; Livevol is an advertiser on VIX and More

Thursday, January 28, 2010

VIX and Mix on Tap Tomorrow at Invest Like a Monster

Starting tomorrow (Friday) and running for two days, the optionMONSTER team (Jon Najarian, Pete Najarian, Guy Adami, etc.) is hosting the San Francisco version of their Invest Like a Monster conference. Included in Friday’s breakout sessions is Chris McKhann’s “Understanding and Trading the VIX” at 11:30 a.m. At 5:30 p.m. is something called “VIX and Mix” that is billed as a reception and an opportunity to fire questions at Jon, Pete and Guy.

I may not be able to make Chris McKhann’s session, but I think it is way past time that I learned the art of VIX and mix and started to do a little meeting and greeting. So if you happen to be at the conference, stop and say hello. I shouldn’t be that hard to spot: I’ll be the one without the pony tail…

For a full list of speakers (including Dan Sheridan, Steve Meizinger and others) and events, check out the Invest Like a Monster agenda or go ahead and register here.

No matter how good or bad your trading has been lately, it is always a good time to soak up new information and cross-pollinate investment ideas.

Disclosure: optionMONSTER is an advertiser on VIX and More

Wednesday, January 27, 2010

Current Pullback Is Fourth Largest Since March 2009

With the futures on a bullish trajectory following President Obama’s State of the Union speech, this seems like an opportune time to reflect on the 67 point (5.9%) fall in the S&P 500 index over the course of the last six days.

The table below – which I have been updating periodically over the course of the last five months – establishes the current pullback as the fourth most severe in percentage terms of the 11 pullbacks of 3.0% or more since stocks turned bullish in March 2009. When I first published the pullback table some five months ago, I was surprised by the strong positive feedback I received and by the volume of subsequent requests I had to update the table. It turns out that investors are very much interested in putting each pullback in historical context, specifically in knowing the magnitude and duration of each significant peak to trough move.

Thinking in those terms, based on today’s low of 1083.11, the current pullback is the fourth largest in peak to trough magnitude as well duration. By all measurements the biggest pullback was 9.1% over the course of 18 trading days during June and July of 2009, which I have highlighted in red and bolded. I have also highlighted in yellow the #2 ranked pullback from October-November 2009 as well as the #3 ranked pullbacks in terms of magnitude (March 2009) and duration (September-October 2009).

In terms of interpretation, the current pullback is certainly above average, but still a good distance from challenging the 9.1% leader or the 10% pullback that many pundits are calling for. For the record, a 9.1% pullback would put the SPX back at 1045; a 10% retracement would bring 1035 back into play. I expect we will see at least one 10% pullback before the year is done, but this appears to be an event that will reward the patient and not the anxious.

For more on related subjects, readers are encouraged to check out:

Disclosure: none

Tuesday, January 26, 2010

Charting the Selloff with an Andrews Pitchfork

In yesterday’s The SPX and an 85 Day Moving Average I expanded on the use of customized moving averages which are reverse engineered so as to neatly circumscribe past price action.

With a little trial and error, it is possible to craft a moving average that fits prior pullbacks, as is the case with an 85 day moving average and the price action in the SPX since last May.

It just so happens, however, that an off-the-shelf charting tool called an Andrews Pitchfork neatly captures the price action during the same period and also identifies a price channel and a trend line that have been critical support and resistance levels during the past eight months.

In the chart below, you can see that the Andrews Pitchfork (named for Alan Andrews) is created by starting with a pivot point (I used a May 2009 cycle low) and then projecting a line between that pivot point and the midpoint of the next cycle high and low (here I used the largest pullback to date, the June-July 2009 9.1% selloff). That line, the middle of the three parallel blue lines, is what Andrews called a median line. The flanking parallel lines (“tines”) are created by projecting the distance between the cycle highs and lows forward in time. The result establishes a trend channel and median lines.

Note that all three of the lines in the Andrews Pitchfork have been significant support or resistance levels in the past eight months. The pitchfork shows that through the end of October, the SPX moved in a narrow range between the median line and the upper tine, with the upper tine acting as channel resistance. Since crossing below the median line in December, the SPX hovered just below the median until the markets sold off last week, at which point the SPX moved sharply down to the lower tine. So far the lower tine has held up as support, which has served to reinforce the value of the pitchfork constructed off of the May-July price action.

Of course, the pitchfork also shows the extent to which bullish momentum has slowed and started to reverse in the past week or so. One more sharp break and a close below SPX 1090 is likely to signal an end to the current bullish trend – at least in Andrews Pitchfork terms.

For more on related subjects, readers are encouraged to check out:

[source: StockCharts]

Disclosure: none

Monday, January 25, 2010

The SPX and an 85 Day Moving Average

In the beginning of November, in Chart of the Week: Reverse Engineering a Critical Moving Average, I talked about the importance of being able to “develop customized moving averages that circumscribe past price action in order to get a better understanding of how current forces acting on stock prices compare to past forces.”

After looking at various ways to optimize moving averages that were critical support levels (at least retrospectively), I arrived at an 85 day moving average for the S&P 500 index as an excellent approximation of support during the March-October 2009 period.

Fast forward to January 2010 and the current pullback has just managed to dip below the 85 day MA on Friday and close above that level today. For now at least, an 85 day moving average is about as good a measure of support as one can find on the charts. In my next post, I will detail what I believe is a meaningful enhancement to the moving average approach.

For more on related subjects, readers are encouraged to check out:

[source: StockCharts]

Disclosure: none

Sunday, January 24, 2010

Chart of the Week: Weekly FXI

Investors who have been waiting for a significant VIX spike to signal a changing of the guard in investor sentiment finally got something to sink their teeth into last week. On the other hand, investors who have been watching China closely have seen a slowly deteriorating picture since about mid-November.

In fact, FXI, the iShares FTSE/Xinhua China 25 Index, is now down 15.8% from its November high water mark and after declining sharply on large volume for the past two weeks is now below its 40 week (200 day) moving average.

As this week’s chart of the week shows, FXI has been locked in a largely sideways pattern since last July after retracing approximately 54% of the fall from an October 2007 high of 69.92 and a subsequent low of 18.95 in October 2008.

Note than in short pullbacks from 2005-2007, the 40 week moving average acted as support. Last week’s breach of the 40 week support line looks more serious than anything experienced during 2005-2007. Should FXI not be able to close this week above the 40 week moving average, I would not be surprised to see that level flip from support to resistance and further confirm that Chinese stocks are in a bear market.

For more on related subjects, readers are encouraged to check out:

Also, for an excellent blog devoted to the fundamentals of the Chinese economy, I highly recommend China Financial Markets by Michael Pettis.

[source: StockCharts]

Disclosure: none

Monday, January 18, 2010

Chart of the Week: VXX Volume Surges

I decided to take a couple of weeks off at the beginning of the year and was amazed to learn retrospectively that as soon as I dialed back my posting, the popularity of the iPath S&P 500 VIX Short-Term Futures ETN (VXX) surged and volume – which had never hit 4 million shares in 2009 – topped the 4 million mark in 7 of the last 8 sessions.

While I am sure the volume surge in VXX is just a coincidence and I can understand why people might think the VIX seems a little low at 17.91 (and at 16.86 a week ago), it is important to note that VIX January futures are now under 20.00 and in the context of historical volatility the VIX is actually somewhat elevated at current levels.

Still, there are obviously quite a few investors for whom the current VIX level does seen warranted given the macroeconomic risks. While some of this gut feeling may be the result of Availability Bias and Disaster Imprinting, there are obviously other factors at work as well.

In this week’s chart of the week, I attempt to capture the price and volume history of VXX, with some of the prior major volatility surges highlighted with the blue vertical bars. The bottom line is that while previous VXX volume spikes did in some instances capture a trough just prior to an uptick in volatility, these were generally small moves of only 3-5 days. Further, while VXX did tend to outperform for a week or more following a volume spike, on balance VXX long positions still lost money from one month to one day following a VXX volume spike. So, while there may be a small ‘smart money’ effect when VXX volume surges, the ‘smart money’ is essentially just losing money at a slower pace with VXX long positions.

I have talked about the problems associated with VXX at length in my subscriber newsletter, but readers should get the gist of my concerns in some of the blog posts linked below.

Specifically, for more on VXX, readers are encouraged to check out:

[source: StockCharts]

Disclosure: none

Sunday, January 10, 2010

Chart of the Week: Regional Banks Rising?

In 2010 I have a bunch of indicators I will be looking at in order to get a sense of how the economy and the stock market are performing. One of the ones I am choosing to profile in this week’s chart of the week is the relative performance of regional banks (KRE) to the broader banking sector (KBE).

The rationale is fairly simple. While the money center banks have benefited disproportionately from various crisis-related government programs and policies over the course of the past year or so, for the most part regional banks have been left to their own devices. The investment hypothesis is that ultimately the fate of regional banks will be a better barometer of the breadth of the economic recovery, the health of the commercial real estate market and the ability of small businesses and local economies to regenerate and grow.

The chart below shows that from the March lows through early October, regional banks were lagging the banking sector significantly, but in the last two months or so, regional banks have rallied impressively relative to a sluggish banking sector and are currently much closer to their 52 week highs than the broader banking index. Regional banks still face considerable obstacles, but their performance relative to money center banks and the broader banking sector should continue to provide an accurate picture of the health of local economies across the country – and one that is less likely to be distorted by policies and legislation coming out of Washington.

For more on related subjects, readers are encouraged to check out:

[source: StockCharts]

Disclosure: Long KBE at time of writing

Wednesday, January 6, 2010

Sideways Markets, Covered Calls and the RUT

I had originally thought that I might begin 2010 with a series of articles on covered calls and other ways of using options to generate additional returns during sideways market action. Since several other writers have already jumped on this subject (notably Jeff Opdyke of the Wall Street Journal in Covered Calls Prove Popular Strategy; Mark Wolfinger of Options for Rookies in Writing Covered Calls in 2010; and Adam Warner of Options Zone in When Is the Best Time to Use a Buy-Write?) I am going to start slowly with these pointers above and a handful of links to previous posts below.

There is another point I wish to make. As of today’s close, the RVX, which is the volatility index for the Russell 2000 small cap index (RUT), is 33.8% higher than the VIX. As the chart below shows, this is at the high end of the range for the past year. Should volatility return to the markets, then I can certainly see how one might anticipate higher volatility in small caps than in the SPX. On the other hand, if stocks are going to continue to move sideways as they did today, then sellers of RUT options (straddles, strangles, iron condors, butterflies, etc.) should receive extra compensation for their short volatility positions.

For more on related subjects, readers are encouraged to check out:

[source: StockCharts]

Disclosure: none

Tuesday, January 5, 2010

Triple ETF Options Landscape One Month After New Margin Rules

On December 1st, the Financial Industry Regulatory Authority (FINRA) implemented more stringent margin requirements for leveraged ETFs in Increased Margin Requirements for Leveraged Exchange-Traded Funds and Associated Uncovered Options.

On that day, I updated my table of all the optionable triple ETFs and now that one month has passed, I thought it might be interesting to see how the activity in these ETFs and their options may have been affected by the new margin requirements.

Using data from, I have captured the highlights below. While not shown here, I should note that in the almost three months from my previous update on September 9th to December 1st, four different triple ETF pairs (UPRO/SPXU, TNA/TZA, DRN/DRV and EDC/EDZ) showed substantial growth in volumes and every single pair showed some signs of increased interest -- so triple ETFs had significant momentum when the new margin rules were implemented. This time around, however, the only notable growth has been in the long bond pair, TMF and TMV, which admittedly comes off of a very small base. Also, there are signs that the large cap pair (BGU/BGZ) and the developed markets pair (DZK/DPK), are starting to lose traction.

Of course, we will never know whether interest in triple ETFs might have plateaued without the FINRA rules, but it is fair to say that FINRA has now stopped the growth momentum of triple ETFs in their tracks.

I will leave it for readers to pick through the data for some other interesting observations, but I would be remiss in not noting that the bear ETF implied volatility has dropped much faster that the bull ETF implied volatility almost across the board.

For the two previous posts in this series, readers are encouraged to check out:


Disclosure: none

Monday, January 4, 2010

SPX Historical Volatility at Two Year Low

While it is widely understood that the VIX has a tendency to fall during the holidays (due largely to fewer trading days), a point that slipped past many pundits is that historical volatility (HV) has been excessively low during the past few weeks. In fact, last Wednesday the 20 day historical volatility in the SPX slipped below 10.00 for the first time since October 2007, about one week after the SPX topped at 1576.

Historical volatility in the SPX did rise a little to end 2009 at 10.23, but even at that level, HV sits at the 17th percentile of SPX 20 day historical volatility readings for the past decade.

For the record, low HV20 readings pushed the ratio of the VIX to SPX HV20 to 2.12 on Friday – a level has only been reached four times in the last decade. Of those four instances, three (January 2000, January 2002 and May 2007) occurred prior to a substantial selloff.

The chart below shows the recent divergence between 30 day implied volatility (red line) in the SPX and 20 day historically volatility (blue line). More often than not, when IV is substantially higher than HV, this is a bearish signal – or at least an indication that it is a good time to take profits.

For more on related subjects, readers are encouraged to check out:

[source: Livevol Pro]

Disclosure: Livevol is an advertiser on VIX and More

Sunday, January 3, 2010

Chart of the Week: The VIX and Volatility in 2009

In this week’s chart of the week, I take a look back at the entire year as seen through the eyes of the VIX and volatility. The first thing you see in this heavily annotated chart is that while the graph of the S&P 500 index for the year looks like a checkmark (a dip down to the March lows followed by a rally), volatility as measured by both the VIX and the average true range of the SPX declined in almost a straight line over the course of the year. In other words, volatility was much less sensitive to market declines in 2009 than it had been in prior years.

Similarly, whereas the VIX peaked at 89.53 in October 2008, it was five months later before the SPX finally found a bottom. Part of the explanation for mean reversion in the VIX leading mean reversion in the SPX is likely due to behavioral finance factors such as those I described in Availability Bias and Disaster Imprinting.

Even with the less responsive VIX in 2009, the full year ended up with the second highest mean VIX for the year (31.48, behind 2008’s record of 32.68) and the highest annual low for the VIX (19.25) since the VIX was launched in 1993.

The chart shows some of the major events on the volatility landscape over the course of the year, as well as other events (black text) that had a limited impact on volatility. Notably absent from the second half of the year is any sort of sustained rise in volatility. Instead, volatility events were short-lived and with one exception, not able to push the VIX over 30. I find it interesting that while rumors of a large U.S. bank in trouble or even the Dubai debt crisis failed to elevate the VIX above 30, the one event that did push the VIX above 30 was more of a trading event (a reversal in the dollar carry trade) than an economic or geopolitical threat to stocks.

For a similar recap of the year in volatility from 2008, readers are encouraged to check out:

[source: StockCharts]

Disclosure: none

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