XLF Volume Spikes 3.3 Standard Deviations Above Mean Yesterday

If I could pick only one ticker to watch in order to gauge the market’s health in the current environment, it would probably be XLF, the most popular of the financial sector ETFs. You could make an argument for RKH, the regional bank ETF, XBD, the broker dealer ETF, or any number of others, but XLF covers the entire financial sector, from Allstate (ALL) to Zions Bancorp (ZION).

With all the talk about the degree of a VIX spike needed to signal a bottom and other measures of capitulation, I am surprised I have not heard anyone else mention the volume in XLF yesterday. As shown in the graphic below, XLF traded over 469 million shares yesterday, eclipsing the previous volume record (set just last Friday), by over 150 million shares. The 469 million share turnover also represents 3.3 standard deviations above the mean, which translates into an extremely unlikely event. [Note that in the chart below, the Bollinger band settings for volume are for 3 standard deviations instead of the default 2 setting] This is capitulation-level volume in the sector that is most important to the stock market at the moment. If XLF can weather all the financial sector earnings due out tomorrow, I suspect that a bottom will be in for the financial sector.

CBOE Launches "Oil VIX" (OVX)

Today the CBOE launched an "Oil VIX" (OVX) based on options on the USO crude oil ETF.

According to the CBOE press release, the exchange is in the process of expanding their volatility index product line into commodities and foreign currencies.

I think this is an exciting development that just happens to fit nicely with several chapters in my upcoming book.

I'll have a lot more to say about the OVX and other CBOE volatility products going forward.

Bernanke and Moody's May Have Accelerated Formation of Bottom

As I type this, the Dow Jones Industrial Average is down about 200 and the VIX has spiked to 30.79, largely as a result of prepared remarks by Ben Bernanke and a downgrade by Moody's of Fannie Mae (FNM) and Freddie Mac (FRE).

As a result of these two developments, some capitulation activity has been accelerated and the likelihood of an intermediate bottom forming today, tomorrow or Thursday is now over 95%.

Volatility and Sentiment Tidbits…and Today Doesn’t Matter

Some semi-random thoughts inspired by today’s market action:

• The VIX:VXV ratio spiked up to 1.12 at 1:12 p.m. EDT (I’m not superstitious, but that’s an interesting bullish signal)
  
  
• The underappreciated VXN (volatility index for the NDX or NASDAQ-100) spiked over 34 on Friday and made it as high as 33.76 earlier today. That’s not enough to satisfy the “VIX must spike over 30!” purists, but it is an interesting data point, particularly because the VXN and NDX excludes financials
  
  
• My VIX algebra says that two medium to large VIX spikes on Friday and today do not equal one large capitulation-friendly VIX spike
  
  
• The CBOE equity put to call ratio – an excellent market timing indicator – is looking bullish

When all is said and done, I don’t think we can have a serious market rally until the tone of the news flow changes, regardless of market technicals and sentiment data. There must be several bullish macroeconomic and/or fundamental data points which collectively give the bulls a reason not to be so skittish. At a minimum, the markets need to navigate the PPI, CPI, industrial production and capacity utilization data due out tomorrow and Wednesday, then weather the flood of earnings reports (with strong representation from some key financial institutions) on Thursday. Even then, there is the Citigroup (C) earnings story on Friday morning.

Whatever happens to the rest of today’s session, the balance of the week will tell the story.

VIX:VXV Ratio Now at 1.10

The VIX:VXV ratio has just hit the 1.10 level, which I consider to be a strong buy signal.

For the record, the 1.10 reading was reached at 12:28 p.m. EDT, with the VIX at a level of 28.97 (+13.21%)

Implied Volatility at Fannie Mae (FNM) Tops 400

Not that this should surprise anyone who has been following this story, but it is an impressive number nonetheless and deserves to be captured here for archival purposes at the very least.

VIX:VXV Ratio Tops 1.08, Signals a Buy

For those out there who have become fans of the VIX:VXV ratio, just a quick heads up that it just moved over 1.08 to generate the first buy signal since mid-March.

For more on the VIX:VXV ratio, click on the link above or the label below.

Implied Volatility of Top Three SPX Sectors

Yesterday, in The Impact of Financial and Energy Stocks on the VIX, I talked about the low (and sometimes negative) correlation between the SPX and some of the sectors represented in the index.

Today I am posting a graphic of the top three sectors (per the Sector SPDR breakdown) in the SPX: technology (XLK: 19.7%); energy (XLE: 15.3%); and financials (XLF: 14.2%). The graph shows a strong correlation between the implied volatility of the SPDR sectors. This should come as no surprise.

Some readers have expressed confusion about correlations between prices and implied volatility. The key takeaway is that SPX implied volatility is not cumulative. The net implied volatility of the SPX is a function of not just the implied volatility of the components or sectors, but also of the directional pull. Let’s take a simplified example. Consider a hypothetical situation in which XLK and XLE are both 18% of the total SPX and both have an implied volatility of 40. If both are perfectly correlated, then 36% of the SPX should have an implied volatility of 40. If, on the other hand, XLK has a correlation of +1.0 (100% positive correlation) and XLE has a correlation of -1.0 (100% negative correlation), then the two sectors cancel each other out and the ‘net implied volatility’ for this 36% slice of the SPX is an even zero.

As a general rule, the higher the correlation among the sectors and individual stocks, the higher the net implied volatility. High implied volatility combined with low or negative correlations generally translates into lower net implied volatility.

For some more detailed individual research into this topic, I recommend Don Fishback’s Index Implied Volatility Is Based on Correlation and Time – It’s Not Just Magnitude!

The Impact of Financials and Energy Stocks on the VIX

The rapidly changing fortunes of financial institutions and energy stocks have been widely chronicled – so much so that there is no need to repeat the details here.

The implications of the shift away from financials and toward energy touch upon several issues that I have not yet seen addressed in the media. One of the obvious ones is the composition of various stock indices. In the S&P 500 index (SPX), for instance, just from 2007 to the present, financials have dropped from 22% of the index to 14% of the index, while energy stocks have surged from 10% to 16% of the index. The change is particularly important when one considers that financials (XLF) have historically been highly correlated to the SPX (0.91 over the course of the past year), while the energy sector (XLE) has typically had the lowest correlation to the SPX (-0.28 for the past year).

Consider that in the past year, the index has been tilting away from financials and toward energy stocks, essentially swapping a positive 0.91 correlation for a negative 0.28 correlation. Given that the VIX is based on SPX options, there can be little wonder why the VIX has been moving more lethargically as of late: an increasingly dominant sector – the energy group – is pulling in the opposite direction of the other sectors. The result? Sector gridlock is dampening the movements of the SPX and of SPX derivatives, like the VIX.

[Hat tip to Adam at Daily Options Report and Don at Don Fishback's Market Update for jump starting some of my thinking on this subject.]

Headwinds Index: Financials (XLF) vs. Oil (USO)

Two numbers have been moving consistently in the wrong direction for the US economy during the past few months: oil prices and bank loan portfolio quality.

The chart below, which reflects a ratio of the valuation of financials (XLF) to crude oil prices (per the USO ETF), neatly captures the recent double threat posed by trends in these two sectors.

You can make an excellent argument that a bottom will not be in until at least one of the two trends, probably both, have reversed. My thinking is that the XLF:USO ratio chart is an excellent tool to monitor those two trends and pinpoint the turnaround. At the very least, I consider the XLF:USO ratio to be a reasonable proxy for two of the major headwinds that the markets are grappling with.

VIX:VXV Ratio Approaches Bullish Territory

One of the better indicators over the past 7 ½ months has been the VIX:VXV ratio, which, as the chart below shows, has been quite accurate in calling tops and bottoms in the market following the VXV launch back in November 2007 and I whose application I pioneered soon thereafter. I mention this because the last time the VIX:VXV ratio gave a clear bullish signal was at the mid-March bottom; and the ratio is coming close to another VIX:VXV bullish signal today.

For more information on the VIX:VXV ratio, try The VIX, VXV and Volatility Expectations. For more information about the VXV, try Thinking About the VXV.

Most Read Posts of 2008 (as of 6/30/08)

I recently received a request to supplement my Most Read Posts of 2007 compilation with something more up to date.

My original intention was to wait until the end of the year to highlight the top posts of 2008, but since this year has already been a historic roller coaster ride of sorts, I see no reason not to take a snapshot at the halfway mark.

So, without further ado, the top 25 most read posts of 2008 (through June 30^th):

1. Ten Things Everyone Should Know About the VIX
2. The Fallacy of the Bearish First Five Days
3. Fear and the Flight to Safety
4. Strong Bear Signal from VIX:VXV Ratio
5. VIX Numbers and Overbought Signals
6. Volatility RIP
7. Equities or Commodities?
8. A Long-Term View of the Put to Call Ratio
9. Implied Volatility Suggests Risks in Financials at Six Month Low
10. SPY Put Volume Study
11. Short Interest Screens
12. Lehman Teetering Again
13. What Is High Implied Volatility
14. Brunhilde Day Today?
15. Persistent High Put to Call Ratio
16. Chart Porn
17. Can Markets Bottom Without a VIX Spike?
18. The Rising Popularity of XLF Options
19. What Fell and What’s Bouncing
20. VIX Macro Cycle Update
21. The VIX, VXV and Volatility Expectations
22. ISE Implied Volatility Charts
23. BIDU Speculators
24. SPX to VIX Ratio Turns Up
25. Volatility History Lesson: 1987

On Measuring Volatility

Mike at HEDGEfolios.com has a good post up today with the title of Measuring Volatility. He touches a lot of bases, but it all starts with the following statement:

“When it comes to measuring or sensing stock market volatility, I do not follow the VIX.”

Now I may have invented that silly tagline, “Your one stop VIX-centric view of the universe,” but I am the first to argue that a defaultist mind set is the wrong way to approach the investment landscape. If you follow the same indicators with the same default settings as everyone else, you are setting yourself up not just to follow the crowd, but to be a half step behind it. In order beat the crowd, what is needed is a variant perception.

Back to HEDGEfolios for a moment:

“The key element of volatility using traditional methods like the VIX rests on the reversal at extremes in a contrarian indication such as buying when the VIX exceeds 30. This is a very dangerous concept and I do not advocate for its use… I never liked that approach so I do my own thing and look at each stock, the turnover in each and how the composite of all signal changes indicates the market volatility.”

Volatility is a wide-ranging concept. It can be defined, measured and applied to over 10,000 stocks and ETFs in many different ways. To think that best way to harness information about volatility is to buy when the VIX hits X is ludicrous.

Consider that the concept of volatility can be applied not just to price, but to volume, options prices, market breadth data, etc. Volatility is a characteristic of every slice of the almost infinite flow of data that is associated with the markets.


It’s not just what you measure, it’s how you measure it. Volatility can look forward when it is in the form of a forecast or a derivation, such as implied volatility. When volatility looks backward, the opportunities to get creative are even richer. There is historical volatility, average true range, Bollinger bands, Chaikin volatility, relative volatility, and a variety of ways in which to index volatility.

Go ahead and watch the VIX, but don’t think for a moment that you are going to have an advantage over the thousands of other people who are watching the same indicator. Sure, you might come up with the next great VIX permutation, but you are far more likely to get a leg up on the competition by revisiting some basic questions:

• Is volatility worth following?
• How can more knowledge about volatility make me a better investor?
• Which aspects of volatility should I pay attention to?
• How should I measure that type of volatility?
• How do I interpret those measurements for maximum ROI?

One of my favorite measures of volatility is the number of buy and sell signals my various systems generate each evening. It’s simple, but effective. And I can be sure that nobody is not going to show up on CNBC tomorrow touting the same approach.

Getting Tougher to Push Financials Lower from Here?

Halfway through today’s session, my screen is once again filled with red, as the indices look as if they are poised to take a run at yesterday’s lows.

From a sector perspective, the picture is considerably muddier, as two recent laggards, financials (XLF) and consumer discretionary (XLY), are clinging to positive territory as I type this. As I see it, one or the other of these sectors will have to continue to deteriorate if the markets are going to continue lower from current levels.

Given that the financials are already down 53% from their May 2007 highs (see chart below), it is important to keep in mind that the easy money has already been made on the short side. A wide variety of financial sub-sectors (mortgage companies, bond insurers, money center banks, regional banks, investment banks/brokers, etc.) have already made multiple trips to the woodshed – and while some individual issues may still be quite vulnerable going forward, there is a limit to the amount of blood that can be squeezed from a broad-based ETF or index.

Going forward, I suspect the risk/return profile of the financial sector may actually favor the bulls. If the next couple of broad market moves down fail to pull the financials with them, the path of least resistance for the likes of XLF may indeed be up. Keep an eye on this development, because if (and admittedly this is a very large “if”) the financials are done falling, then the markets are likely to be ready to put in a bottom too.

Fearogram Maps Recent VIX Complacency

There has been so much talk about complacency in the VIX that I thought I should dust off the old fearogram and see just how complacent the VIX has been as of late.

For those who are new to the concept of the fearogram (a term I hatched last October), it is essentially a chart of the daily change in the VIX vs. the daily change in the SPX. (For more background on the fearogram concept, try previous posts with the fearogram label.)

The chart below plots a best fit diagonal black line which represents a ratio of the daily percentage change in the VIX to the daily percentage change in the SPX for every trading day going back to 1990. Essentially, the larger the distance between individual data points and the fearogram best fit line, the more extreme the level of fear or complacency. For data points above and to the right of the best fit line, the VIX is increasing out of proportion to the drop in the SPX, indicating more fear. For data points below and to the left of the best fit line, the relatively muted reaction of the VIX suggests more complacency. Data points that hug the best fit line are indicative of a VIX that is consistent with typical historical relationships between the VIX and the SPX.

In the chart below, the blue diamonds are plots of individual daily ratios of VIX and SPX percentage changes for each day during the past two weeks. In studying the chart, note that during the past two weeks, the VIX has never once shown more fear than is reflected in the average daily ratio.

Of course, today is looking like it could be the day the tide finally turns.