Friday, March 22, 2013

The Low Volatility Story in Pictures

Lately I have not been able to help being bombarded by articles extolling the virtues of investing in low volatility (also known as minimum volatility) exchange-traded products. These ETPs typically talk about the tendency of investors to become overly enamored with some of the sexier, more volatile stocks and accordingly bid these up to unsustainable valuations. On the other hand, the tortoise-like approach to lower volatility stocks tends to avoid these stocks that are fashionable for short periods of times, so-called “story stocks,” momentum favorites, and stocks with hockey-stick charts that sometimes become mini-bubbles. Instead, plodding growth, dividends and total return are the main areas of focus.

I have discussed the most famous of these low volatility ETPs, the PowerShares S&P 500 Low Volatility Portfolio (SPLV) in a number of different contexts in this space, including:

This time around my intent is to let the graphics speak for themselves, so without further ado, I give you three snapshots of the performance of SPLV against the performance against its more volatile sibling, the PowerShares S&P 500 High Beta Portfolio (SPHB).

SPLV vs. SPHB since inception (472 days):


SPLV vs. SPHB over the last 380 days:


SPLV vs. SPHB over the last 200 days:


I realize that every historical period in the financial markets is unique and that one can cherry pick graphics to make any imaginable point, but I think the three charts above tell almost the full story, which is this:

1.  Over the long-term, low volatility stocks have a high probability of outperforming high volatility stocks on an absolute basis and particularly on a risk-adjusted basis

2.  Even in bull markets, the total return approach of low volatility stocks often makes them comparable to or even superior to high volatility stocks

3.  The biggest risk associated with a low volatility approach is being left behind in a sharp bull move, when more defensive sectors can underperform substantially

The real question to ask yourself is which risk concerns you the most: a large drawdown or missing out on a large chunk of a bull rally?

Related posts:
Disclosure(s): none

Tuesday, March 19, 2013

Another Record in VIX Call Volume

Exactly three weeks ago today, I thought I would break some news on an intraday basis with a post that I titled, Record VIX Options Volume and Large Purchases of VIX Calls. As it turns out, by the time the day’s total volume was tallied, February 26th turned out to be an all-time record for VIX options volume in general and VIX calls in particular.

The events of three weeks ago now look a little less impressive in light of today’s new record in VIX call volume. Truth be told, VIX options seem to be attracting the attention of a new group of investors. In fact, during the CBOE Risk Management Conference earlier this month, there was a great deal of speculation surrounding who some of the new players in the VIX space might be that are responsible for the new growth in VIX futures and VIX options that appears to be independent of the volume driven by VIX ETPs[Hedge funds, proprietary trading firms, commodity trading pools/advisors, insurance companies, bond traders, FX traders and others were among the names that were bandied about…]

As is typically the case with the VIX, call volume outpaced put volume by a substantial margin. Today the call to put ratio was about 2.2 to 1, slightly higher than the average of 1.9 to 1. That being said, put buyers appeared to be a little more aggressive than call buyers, with 42% of all puts bought on the ask, as opposed to 30% of the calls, according to data provided by LivevolPro.

Investors are always looking for an interpretive overlay for these VIX options transactions. Frankly, on the day before the March VIX expiration, a great deal of the options activity is the result of large investors closing out March positions or attempting to game the special opening quotation (VIX SOQ) from tomorrow’s open that establishes the settlement price for VIX options and futures.  As a result of that low signal to noise ratio, the day prior to expiration is generally not a productive time for reading options entrails, though there will no doubt be some who are hell-bent on some sort of options divination regardless of where we are in the VIX expiration cycle.  For today at least, I would suggest that the links below might bear more fruit. 

Related posts:


Disclosure(s): Livevol and the CBOE are advertisers on VIX and More

Monday, March 11, 2013

Lowest VIX Close Since Day Before Biggest VIX Spike Ever

I’m generally not one for sensationalist headlines, fear-mongering or otherwise stirring up trouble unnecessarily, but when facts line up in a manner that I know others will find interesting, I do feel an obligation to point that out.

So…at the risk of being splashed all over the Zero Hedge comments stream I thought it worth noting that today the VIX closed at 11.56. While this marks the lowest close in the VIX in over six years, a surprising portion of this low VIX is the result of a calculation quirk I described earlier today in The VIX, Interpolation and the Roll. In other words, I would characterize today’s VIX as artificially low and considerably lower than the near-term VIX calculation (VIN).

That being said, there is no denying that the last time the VIX closed below today’s close was February 26, 2007, the day before The Biggest VIX Spike Ever, a 64% jump in one day.

Do I expect a new record VIX spike tomorrow? Hardly, though I should note that just two weeks ago today we did see the #11 all-time VIX spike for a single day.

What is more likely to happen is that the negative coefficient for the weighting of the far-term VIX calculation (VIF) will slowly dissipate over the course of the week and that in itself should lift the VIX about three-quarters of a point. Throw in a just one or two days of declining stocks triggering the purchase of SPX puts for portfolio protection and it would be very easy to see the VIX up more than 20% from its current level by the end of the week.

Looking back at the concerns that dominated my fear poll a couple of months ago, most of these have dramatically receded. For this reason, it looks like it will take one of those unexpected threats to get the VIX airborne once again.

Related posts:

Disclosure(s): none

The VIX, Interpolation and the Roll

Almost every month, some subset of the class of investors and journalists expresses extreme alarm when the VIX magically plummets on the Monday before the standard monthly options expiration that occurs on the third Friday of every month.

I have written about this before, notably in:

The executive summary is that for most of its monthly cycle the VIX is an interpolated value derived from the first and second month S&P 500 index (SPX) options contracts. In an interpolation, one is presented with two values and attempts to derive a value that is in between those two, typically by drawing a straight line between the values and attempting to determine where on that line the desired value should fall. When one wants to derive a 30-day VIX and the SPX options contracts are, say, 17 and 45 days out, then a simple linear interpolation accomplishes that goal – and that is what the VIX calculation methodology does.

Things become more interesting due to the fact that the CBOE mandates that the near-term month used in the VIX calculation have at least one week to expiration. So what happens is that on Friday the VIX used the March and April expirations in the VIX calculation; today April becomes the near-term month and May becomes the far-term month. With the April expiration falling on April 19th and the May expiration on May 17th, this means the two months used in the VIX calculation have 39 and 67 days until expiration, respectively. So how does the CBOE arrive at a 30-day VIX value? Well, they still use the near-term VIX calculation (VIN) and far-term VIX calculation (VIF), but they accomplish this task by using a negative coefficient for the weighting of the far-term value, in addition to a coefficient that is greater than 100% for the near-term value.

There is nothing wrong with this approach and it delivers reasonable numbers when the near-term and far-term VIX have roughly the same value, but when there is steep contango in the SPX options term structure, which has frequently been the case over the course of the past two years, the resulting VIX calculation can be dramatically lower than both VIN and VIF. Right now, for instance, the VIX is at 11.71, while VIN is 12.48 and VIF is 13.50.

My suggestion would be not to focus too much attention on the VIX while the calculation uses a negative coefficient for VIF, which will be for the remainder of this week. Instead, those looking for a better gauge of what the VIX is should probably focus on VIN for the next four days.

Alternatively, one can refer to SPX implied volatility calculations provided by their options data provider, such as are incorporated into the SPX skew graphic below, courtesy of LivevolPro.

Related posts:


Disclosure(s): Livevol and the CBOE are advertisers on VIX and More

Wednesday, March 6, 2013

Some Thoughts on the CBOE RMC

The 29th Annual CBOE Risk Management Conference (RMC), wound down yesterday, proving that while Chicagoans and New Yorkers were happy enough just to escape the snow, there were some excellent business reasons for making the trip to southern California.

What I like to call the “VIX Summit” is no doubt the best place for VIXophiles to congregate, get acquainted, and exchange ideas related to a subject that tends to be arcane and poorly understood in most quarters, yet is increasingly embraced by a wide variety of practitioners. Nancy Davis of AllianceBernstein probably summarized best what is happening in the volatility space when she identified three trends that are driving institutional use of options:

  1. New entrants
  2. Cross-asset class opportunities
  3. Structural differences

In terms of new entrants, the VIX product space is seeing a wide range of new institutional interest from hedge funds and proprietary trading firms to CTAs (commodity trading advisors), insurance companies and other firms, many with an international flavor. One of the common themes is the search for yield enhancement strategies. A lot of this activity can explain the recent surge in volume in VIX futures and VIX options. Whereas VIX ETPs had been driving volumes in VIX futures in the past, now growth is being driven by the participation by a broad range of new institutional players, some of whom are “curve hopping” from Treasuries to the VIX and many of whom are motivated by the lack of compelling alternatives to enhancing yield.

In these types of events there is always one presentation that catches you by surprise and gives you a lot of ideas to ponder that had not necessarily been on your radar. For me that presentation came from John Coates, the author of The Hour Between Dog and Wolf: Risk Taking, Gut Feelings and the Biology of Boom and Bust. In a wide-ranging talk, Coates has some compelling observations on physiological systems and how these are intertwined with everything from pleasure and addiction to expectations, uncertainty and risk assessment. Frankly, even if the subject of trading was not directly incorporated into this presentation, this talk still probably would have left me with more to chew on than the other presentations.

In the U.S., the RMC alternates between Florida in even years and southern California in odd years and is typically held during the last week of February or the first week in March. Last year a CBOE RMC – Europe conference was added in Ireland. The success of that conference has translated into a repeat performance that is scheduled for September 30 – October 2, 2013 at the Penha Longa Hotel in Sintra, Portugal, just outside of Lisbon. As a port fan who has never been to Portugal, I can certainly envision a trip to Portugal in September in addition to Florida next year.

Last but not least, thanks to all those I the pleasure of meeting this week.

[photo: near Big Sur, California]

Related posts:

Disclosure(s): the CBOE is an advertiser on VIX and More; VIX and More is a sponsor of the CBOE Risk Management Conference

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