Thursday, July 19, 2012

Crazy VIX:VXV Ratio Chart

There was a point in the history of VIX and More that I gave serious consideration to a regular feature in which I unveiled “Strange and Unusual Charts” that presumably had, apart from their novelty, the ability to shine some new light on at least one corner of the investment universe. That being said, I have always had an affinity for presenting charts that show unusual ratios, non-standard time frames and such and while the likes of Chart Porn and Unusual Chart of the Month: VXO and RVX did get me started down a slippery slope, I never quite fell into the habit of tilting wildly at windmills on the plains of and their brethren.

One rabbit hole that I was definitely the first down and pursued the most aggressively was the VIX:VXV ratio, which one blogger insisted was sure to ultimately be my investing legacy. In all fairness, for the first year following the launch of VXV (essentially a 93-day version of the VIX), the VIX:VXV ratio performed as if it was going to make all other indicators obsolete. Of course, then the financial crisis of 2008 hit and the ratio began sprouting warts all over. While I talk about the VIX:VXV ratio only rarely in this space nowadays, the general idea of which the VIX:VXV ratio is just one instance of what has become one of the main themes of this blog: the idea that an understanding of the VIX futures term structure is critical to understanding the valuation of and trading opportunities available for all VIX products, including futures, options and exchange-traded products.

All of which brings me – somewhat belatedly, perhaps – to today’s chart, which is right out of the same cauldron that produced some of the curiosities of yesteryear. The chart below captures 2 ½ years of daily bars in the VIX:VXV ratio and adds some green Bollinger bands for color and context, along with a gray area graph of the SPX. Finally, I have included a purple line for the VIX:VXV ratio that reflects a 500-day exponential moving average (EMA) in order to show the long-term average of the ratio.

While there are many interesting nuggets buried in this chart, first note that the long-term average of the VIX:VXV ratio is not 1.00, but generally hovers in the 0.90 – 0.95. This reflects the fact that the VIX futures term structure has historically been in contango (upward sloping, with nearer months less expensive than more distant months) 75-80% of the time. Second, note that spikes in the ratio tend to coincide with bottoms in stocks and vice versa. Finally, note that even with the crazy VIX spike last August and September (and record backwardation, i.e. high VIX:VXV ratios), the ratio has been depressed since December and the 500-day EMA is now making all-time lows.

What does this mean? Lots of things, but in simple terms investors continue to believe that the VIX is unnaturally low given the scope and magnitude of the future threats to equities. Should the ratio continue at its current 0.83, I would be very concerned about the possibility of a bearish reversal.

[In order to keep this post to a manageable length, I have skipped over a bunch of related issues, but readers should feel free to wander down some of the same rabbit holes I have preserved in the links below.]

Related posts:


Disclosure(s): long VIX at time of writing

Tuesday, July 17, 2012

Why VIX Puts Get Cheaper in More Distant Months

Today I fielded several questions related to the valuation of VIX puts – a subject that can be a head-scratcher for even the most seasoned investors.

The put matrix graphic below, courtesy of optionsXpress, shows bid-ask quotes for VIX puts from July (which expire at tomorrow’s open) through December.

With the VIX at 16.21 at the time of this screen capture, note that for the 17s the prices for August through December have already factored in some mean reversion. For this reason, the August 17s are the most expensive on the board, with a bid-ask midpoint of 1.05. The September 17s are quoted at 0.875; the October 17s are at 0.75; and both the November and December 17s are at 0.675.

One way to interpret this put matrix is that if you were to pick any month other than the current one that the VIX is most likely to close below 17, then August is your month. Additionally, if you expect to get any money for selling VIX 17 puts, then August is the best month to target.  This is because the moneyness of the VIX options considers the full VIX term structure and with the VIX futures in steep contango, the back months are a full nine points higher than the front month (July) VIX futures.

[As an aside, things get even crazier when trying to structure calendar spreads with VIX puts. In fact, the best way to think about these trades is to consider them not to be spreads based on one underlying, but two different trades based on two different underlyings: the VIX futures for each corresponding month. This details of this subject is fodder for another post.]

Finally, for those who might consider selling VIX puts – always an interesting strategy, but often with surprisingly little premium involved – the key risk management concept to consider is that the direction of the spike in the VIX is almost always to the upside and only rarely to the downside. Short of a QE3 announcement, it is difficult to anticipate the type of news which would push the VIX under 15.00 for an extended period.

For more on the VIX put matrix, the pricing of VIX puts and some of the strategic implications, check out some of the links below.

Related posts:


Disclosure(s): long VIX at time of writing; optionsXpress is an advertiser on VIX and More

Monday, July 16, 2012

Trading Options in CORN

I am firmly of the Jim Cramer school of thinking that believes, “There is always a bull market somewhere.” Of course, with the advent of inverse exchange-traded products ETPs), you can turn just about any bear market upside down and transform it into a bull market...

With stocks stuck in a sideways drift for the last two months, the one corner of the financial markets that has been red hot has been corn. Since the beginning of June, corn futures are up more than 40%, rising from $5.51 per bushel to $7.73 per bushel. While institutional investors have been actively bidding up corn futures, most retail investors are likely to prefer the ETP route, where the Teucrium Commodity Trust Corn Fund ETF (CORN) is the only pure play on corn.

Back on July 5th, with corn at $7.19 per bushel, I talked about the potential for corn to go parabolic when I observed:

“Extreme price moves are not uncommon, particularly when unusual weather patterns are involved…Note that while the June-July 2012 move in corn looks impressive, it pales in comparison to the spikes in corn prices that occurred in 1994-1996, 2005-2008 and 2010-2011. In other words, this could be just the beginning of a huge move in corn prices, particularly given that the price move of the last month or so comes on top of a much higher base.

Corn may be putting in a top soon, but a fat-tailed spike is not guaranteed to top out at the prior highs of $8.00 per bushel.”

Whether you are long or short – or have no position in CORN (or corn futures) – the current environment looks like an excellent time to think about CORN options. Traders who are long CORN are likely sitting on substantial gains and while some maybe be tempted to take some profits, the possibility of a breakout above $7.73 per bushel is just too attractive to part with that position. For this reason, longs may wish to consider the commodity/ETP version of a stock replacement strategy. Here the idea is to sell the CORN ETF, pocket the profits, and use a portion of those profits to buy some out-of-the-money CORN calls. With the CORN ETF closing at 49.85 today, the August 50s, 55s or even 60s might be a reasonable target. Should CORN reverse direction, a portion of the initial profits will be retained, but if there is another big bull leg, this options trade could turn a solid winner into the trade of the year.

Shorts might consider a similar limited risk approach. Rather than run the risk of continuing to be squeezed by a speculative buying frenzy, one strategy that makes sense is to close out any short CORN (or corn futures) position and buy some out-of-the-money puts. The August 45s and 46s are a popular choice, but there are some other excellent alternatives.

Finally, perhaps you have no desire to make a directional trade in corn and believe all the hype overstates the reality and prices are likely to remain a lot closer to their current level than spike again or plummet. Here a short strangles or straddles are sensible approaches, as are their limited risk counterparts, condors and butterflies.

If any of this sounds familiar, readers may recall that I made the argument for a similar strategic approach with silver at the height of the silver frenzy on April 27, 2011 in Is Volatility a Better Play for Silver Than Direction? With the benefit of hindsight, that post was published just two days after what turned out to be the intraday top in silver and two days before silver’s all-time closing high. I’m not saying the top in corn is here right now, but every day we get a little closer to that top and some of the options trades get a little less attractive.

Related posts:


Disclosure(s): neutral position in CORN (via options) at time of writing

Friday, July 13, 2012

Rally Leaves Spanish Banks Behind

Stocks are firing on all cylinders today, with the S&P 500 index up more than 1.4% as I type this and most heat maps showing nothing but various shades of green. Even European stocks are strong today. With Europe’s exchanges closed for the weekend, the European country ETFs have followed the U.S. markets higher, though Spain’ ETF (EWP) has been a laggard.

Look at the ADRs for Spain’s banks, however, and it appears that the banks are not participating in today’s rally. Spain’s largest bank, Banco Santander (ticker SAN, previously STD until one month ago today) had managed a gain of just 0.03 today, while the country’s #2 bank, Banco Bilbao Vizcaya Argentaria (BBVA), is off 0.04.

In short, it appears that no matter what the U.S. markets do or the euro zone leaders say or do, stocks for these Spanish banks continue to act as if they are swimming in concrete shoes.

The chart below shows the price action in BBVA since the beginning of 2011, as well as a study on top of the main chart that tracks the performance of BBVA relative to SPY for the same period. In the ratio chart study, I have thrown a 200-day moving average of BBVA:SPY (solid blue line) to underscore that not only has the trend been consistently down, but the ratio has not even come close to trading over its 200-day moving average at any point in the past 1 ½ years.

For the record, the chart for SAN and the SAN:SPY ratio is equally ugly and a similar chart of EWP:SPY is no better than a chart of the Spanish banks.

It remains to be see how the situation with Spain and its banks will be resolved, but until there is some sort of resolution on the horizon, I would to continue to expect to see considerable activity in the puts of SAN and BBVA.

Related posts:


Disclosure(s): short SAN and BBVA at time of writing

Tuesday, July 10, 2012

Guest Columnist at The Striking Price for Barron’s: How to Trade Options Around Volatile Events

Once again I am happy to be able to pinch hit for Steve Sears and his The Striking Price column at Barron’s. In How to Trade Options Around Volatile Events, I expand on some of the thinking that I first laid out in 2008 in A Conceptual Framework for Volatility Events. Specifically, I discuss some of the trading opportunities associated with event volatility and tie that in to FOMC meetings, the European sovereign debt crisis and similar sources of volatility.

For the record, I generally try to accomplish three things when I write a column for Barron’s:

  1. tackle a subject (or two) that is timely and relates directly to current events
  2. focus more on concepts and ideas than a specific trading opportunity
  3. weave in some of my original research and analysis

Given all the is going on in the world and all the deadlines and key events that loom in the next six months, the subject of how to trade options around volatile events deserves much more discussion – and I will do what I can to fill that gap in the weeks and months ahead.

Related posts:

A full list of my Barron’s contributions:

Disclosure(s): none

Saturday, July 7, 2012

Chart of the Week: As Goes Spain…

Two years ago today, in Spain rallies, I posted a chart of the Spanish ETF, EWP, that showed EWP had rallied off of a bottom and looked like it was poised for a bullish breakout.

In July 2010, I saw Spain as the keystone in the euro zone puzzle:

“Spain is the tipping point in the European sovereign debt crisis as I see it. In a nutshell, as goes Spain, so goes Europe.”

Two years later, I still believe that Spain is the most important line in the sand that euro zone leaders have to grapple with and the country whose fate is probably most intertwined with the future of the euro.

The chart of the week below shows weekly bars of EWP going back five years. The dominant feature in this chart is the financial crisis of 2008-2009. Various iterations of the euro zone crisis can be identified in the bottoms in June 2010, September 2011, November 2011, etc. EWP was in a gradual downtrend from April 2011 to March 2012, but fell sharply until the beginning of June. The most recent bounce in the Spanish ETF still looks somewhat tentative on the charts and is likely to be tested in the weeks and months ahead.

As concerning as the equity situation looks in Spain, the country’s credit default swaps (just 8% off of their all-time highs at 578) and yields on sovereign debt (yields on the 10-year bond are 5% below their all-time highs at 6.95%) indicate an even greater degree of financial stress.

At one time or another, I would expect Italy, France to find their way back into the crosshairs of traders who are looking to capitalize on euro zone angst, but as far as I am concerned, Spain will continue to the most critical line in the sand.

Related posts:


Disclosure(s): none

Friday, July 6, 2012

The Economic Data Cliff

Just a little over a month ago, in Worst Post-2009 Week in Economic Data Relative to Expectations (no I have never written headlines for a living…) I detailed the rapidly deteriorating picture of economic data relative to consensus expectations.

After talking about the very disappointing economic reports, I noted the one historical parallel:

“[t]he only other time there was a week in which data was this poor relative to expectations was in the middle of February 2011, at which point the data was pulling back from an all-time high, about 2 ½ months before data and equities topped and began their swoon.”

Five weeks later what looked like one bad week now looks like a horrific two month stretch. The chart below details the trend in economic data relative to expectations going back to the beginning of 2010. Note that the last two months not only include the sharpest short-term decline in economic data in three years, but also reflect a stock market that seems decoupled from economic data for the first time since stocks began to rally in 2009.  Prevailing opinion is that the decoupling from economic reality is merely a case of postponing the inevitable decline in stocks, but there also exists the possibility that stock prices are beginning to reflect an economic turnaround at the end of the year or in early 2013.

[Readers who are interested in more information on the component data included in this graphic and the methodology used are encouraged to check out the links below. For those seeking more details on the specific economic data releases which are part of my aggregate data calculations, check out Chart of the Week: The Year in Economic Data (2010).]

Related posts:

[source(s): various]

Disclosure(s): none

Thursday, July 5, 2012

Recent Corn Rally in Context of Twenty Years of Corn Futures Prices

Since the launch of the Teucrium Commodity Trust Corn Fund ETF (CORN) in June 2010, investors who were unwilling to open up a futures account have been able to take long and short positions on corn via the CORN ETF, which holds a basket of corn futures.

Investors who are new to corn or to commodities in general may have been surprised by the big move in CORN, which is up 20% in the past two weeks and 28% over the course of the past month. No doubt they probably believe that the move in CORN (and corn futures) is likely to soon be exhausted.

While CORN/corn may indeed be about to peak, I would urge new arrivals on the commodity scene to study the history of agricultural commodities prices over the years and note that extreme price moves are not uncommon, particularly when unusual weather patterns are involved. The chart below uses monthly bars of corn futures over the course of the last 20 years. Note that while the June-July 2012 move in corn looks impressive, it pales in comparison to the spikes in corn prices that occurred in 1994-1996, 2005-2008 and 2010-2011. In other words, this could be just the beginning of a huge move in corn prices, particularly given that the price move of the last month or so comes on top of a much higher base.

Corn may be putting in a top soon, but a fat-tailed spike is not guaranteed to top out at the prior highs of $8.00 per bushel.

As an aside, if you are going to trade CORN or corn futures, it would certainly help to become a weather guru, but be forewarned that understanding the weather nuances that affect corn prices is no easy task.

Related posts:


Disclosure(s): long CORN at time of writing

Monday, July 2, 2012

Chart of the Week: VIX Reversal Signal Coming Soon?

Sometimes the simplest ways to analyze the VIX are the best.

The chart of the week below shows weekly bars of the S&P 500 index and the VIX going back three years. In the VIX study at the bottom, I have also highlighted in yellow the zone from 15-18, which has proven to be a fairly robust zone of support for the VIX during this period. Note that while the VIX has slipped below 15 on occasion, it has eventually bounced off of this support level in each instance and, perhaps more notably, a VIX bottom in the 15-18 range has also coincided with a top in the SPX each time around.

With the VIX in the low 17s as I type this, bulls and bears alike should be on the lookout for signs of a bottom forming in the VIX – and be prepared to position their portfolios accordingly.

Related posts:


Disclosure(s): none

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