Regional Banks in Trouble

While the first six weeks of 2009 have seen pockets of bullishness in stocks, one sector that has been notably absent from the occasional bursts of buying activity has been financials. Within the financial sector, the weakest of the weak has been regional banks, which will see little in the way of benefits from TARP 2.0 and stand to lose a great deal if the consumer credit crisis continues to deepen, as almost everyone now expects will be the most likely scenario.

In the three month chart below, you can see that since the beginning of the year, the S&P 500 index has given up about half of the gains it has made since the November 21^st bottom. The regional banks, on the other hand (represented here by KRE, an ETF), have fallen sharply below their November lows and are now even below the lower lows of January and early February.

There is little doubt that regional and local banks have huge fundamental challenges ahead of them. I have seen estimates that 10% or more may even fail before the economy can be nursed back to health.

If regional banks continue to reflect deteriorating valuations, I find it hard to believe that the broader market will be able to shake off this concern and manage a significant rally. At the very least, I would expect the market to be no better than range bound at least until the stocks of regional banks can be taken off of life support.

[source: BigCharts]

Thinking About Volatility (First in a Series)

Lately I have been fielding a large number of questions about historical volatility, implied volatility and a variety of related subjects. For this reason, it seems like a good time to kick off what I envision as a series of educational posts on the subject.

First I would like to start out with my own definition of volatility and then throw out some thought starters.

Definition: Volatility is a measure of the degree of change in the price of a security

There are a number of ways to think about changes in the price of a security. For instance, changes in price may be described in terms of:

• magnitude (amplitude) – how far?
• frequency – how often?
• duration – how long?
• trend – unidirectional or choppy?
• direction – up or down?

In terms of measurement, common ways to measure price changes include:

• close to close
• open to close (intra-bar; excludes gaps)
• bar to bar maximum (e.g. Average True Range)

Of course each investor has their preferred unit of time, with each bar representing a minute, five minutes, one day or whatever.

By convention, most investors think of volatility in terms of changes in price, but I submit that volatility be measured in the following units:

• points
• percentage (of price)
• standard deviations

Looking back at the definition, I sometimes like to think of volatility more broadly than I have formally defined it. Consider that volatility can be defined in terms of:

• price
• volume
• trend (degree of trending vs. choppiness)

Finally, consider that once measured, volatility can be compared to a number of possible benchmarks. These include:

• external aggregate (broad index)
• relative to peers (sector index, sector ETF, other representative ETF)
• relative to self (including historical volatility and prior implied volatility levels)

I will touch upon all these subjects and more in the coming days and weeks.

Some Early Thoughts on the Performance of VXX, the VIX Short-Term ETN

VXX, the iPath S&P 500 VIX Short-Term Futures (1 month) ETN, has now been traded for all of eight sessions. No one in their right mind would attempt to draw some conclusions on so little data, would they? Well, right-minded or not, I am always up for a challenge.

In no particular order, here are some factoids from those first eight sessions with the new VIX ETN:

• in eight days, VXX has averaged 204,751 shares (for comparison purposes, FAS, which traded 160 million shares today, averaged 127,851 shares in its first eight days)
  
  
• for seven of the eight days, VXX has moved in the same direction as the VIX (on Monday, 2/2, VXX fell while the VIX rose)
  
  
• on three of the eight days (Thursday through yesterday), VXX has registered a larger move in percentage terms than the VIX
  
  
• on average (mean, median, etc.) VXX has been moving at a rate of about 85% of the VIX
  
  
• the average intraday range for VXX is (4.51%), with a maximum of 6.93% today and a minimum of 2.51% yesterday
  
  
• so far the ratio of the VIX to VXX has hovered around .439

Post-Geithner Financial Naked Calls

For the extremely aggressive (and well-capitalized) investor who believes volatility in financials is on the high side and may also have some bullish directional bias, something like a bear call spread with FAZ, the -3x financial ETF, might be an interesting trade to look at.

The truly fearless might even look at selling an out of the money FAZ naked call. As I write this, FAZ is trading with a 48 handle and a Feb 50 call sale will bring 7.20, which means there is room for almost 20% upside movement in the ETF before the trade turns unprofitable. Of course, with the likes of triple ETFs FAZ and FAS, 20% moves can happen in a matter of hours…

[source: optionsXpress]

Pre-Geithner Financial Butterflies

At this stage of the game, it is difficult to predict whether the markets will sell on the news following Geithner’s speech or rally on the possibility of progress.

One thing is much more likely: uncertainty and volatility associated with financial stocks is likely to drop significantly.

There are a number of ways to play the financial volatility game. A basic one is with a long butterfly spread, such as the one shown below, in which XLF is profitable if it stays in a 9.28 – 10.72 range in the next 1 ½ weeks.

[source: optionsXpress]

Marty Chenard and the VIX RSI (30) [REVISED]

For those interested in charting and technical analysis, Marty Chenard of StockTiming.com has an excellent stable of charts that he uses as a jumping off point to analyze the markets. Every trading day he has a new free chart and once a week or so he manages to work the VIX and volatility into the conversation.

Unfortunately, at least for the non-subscriber, Chenard’s charts scroll off each week as they are replaced by new ones, but Headline Charts recently captured one of Chenard’s VIX ideas in a post. Headline Charts maintains that according to Chenard, markets do not advance on the basis of a declining VIX alone, but also require that the declining VIX transpire in the context of a VIX with an RSI (30) above the 50 line.

In the six month chart provided by Headline Charts, one can see that the VIX has spent very little time above the 50 line for the RSI (30) during the course of the past six months? Could this be part of the reason why the markets have had such difficulty putting together a convincing rally?

In the chart below, I go back to 2003 to take a longer view of Chenard’s VIX RSI theory. Without crunching any numbers, visual inspection already has me skeptical about the advisability of waiting for a declining VIX with an RSI above 50. I have highlighted four significant bull moves in which there was a declining VIX and an RSI (30) below 50.

I will subject the VIX RSI theory to some further testing, but at first blush I have difficulty finding support for Chenard’s VIX RSI market timing approach.

[I have decided to leave the original post up, but have added the following comments.]

Thanks to Quantifiable Edges for giving my reading comprehension a nudge and for giving me an opportunity to have my own Emily Litella moment. In rereading the Headline Charts piece, I am now persuaded that Chenard was talking about the RSI (30) of the SPX instead of the VIX. This makes a lot more sense to me and shows much more favorably on the charts. Here is a similar chart to the one above, with the RSI (30) for the SPX instead of the VIX. Now I like his theory a lot better…

[graphics: StockCharts]

Chart of the Week: SPX Price by Volume

There are many methods that technicians use to help determine when various market moves may run into significant support and resistance. Moving averages are one common method, pivot points are another, and Fibonacci retracement levels are one of my personal favorites.

Another method of gauging support and resistance involves the use of charting price by volume. As I have lately heard very little about price by volume charts, this seems like a good time to make these charts the subject of this week’s chart of the week.

In the graphic below, in addition to the standard daily volume vertical bars at the bottom, I have used one of the StockCharts tools to plot horizontal bars that represent the total volume for all the days in which the closing price fell in the range described by each horizontal price by volume bar. The longer the bars, the more volume that was transacted within that price range. For more detailed analysis, I have also color coded the price by volume bars so that total volume for each price by volume range can be further decomposed into up volume (gray) and down volume (red).

In terms of time frame, I have used SPX data from the beginning of October 2008, when the SPX first dipped below 1000, to illustrate possible resistance. Note that during this 18 week period, a large portion of the volume fell in the range of approximately 820-920.

With the SPX currently just one point below its 50 day simple moving average (dotted red line), additional upside movement may be harder to come by. According to price by volume charts, however, the biggest resistance should be in the 890-920 area, where not only is the volume by price bar a long one, it is also predominantly red from previous selling pressure.

If the SPX can clear 920, then resistance (as indicated by the length of the bar and also the ratio of red to gray area) seems to fall off dramatically, with 955 looking like a much less formidable hurdle on the road back to 1000.

Of course the charts have no idea what Geithner is going to say on Monday, nor how the House and Senate will resolve their different perspectives on what needs to be included in the economic stimulus package.

[source: StockCharts]

Condor Options Looks at Volatility Forecasting

Volatility forecasting is a subject that I spend a lot of time with behind the scenes, yet rarely post about on the blog. Part of the reason for my reticence to post on the subject is that my own efforts to develop a volatility forecasting model have demonstrated that whatever proficiency I am developing seems to be limited to at most a 2-3 week forecasting period.

That being said, whenever I see Condor Options write about a subject that I have an interest in (which is almost every time something appears on their site), I take notice. Today my avian friends are tackling Forecasting S&P 500 Volatility, using a variety of approaches, including SPX implied volatility, VIX futures and a trio of GARCH(1,1) forecasting models. The consensus? None, really. The SPX IV data anticipates the most volatile future, while the GARCH(1,1) models see volatility dropping off more rapidly. Check out the full article for the details.

My forecast? Partly cloudy, with a chance of gradually diminishing volatility over the course of the next 2-3 weeks.

Historical Volatility Dropping Below VIX Again

One of the better tools for determining whether the VIX may be too high or too low is to compare the VIX to recent historical volatility levels in the S&P 500 index. Unlike the VIX, which is measured in calendar days, historical volatility is measured in trading days, so 21 days of historical volatility has about the same time horizon as the 30 days used in VIX calculations.

Instead of 21 day historical volatility, most practitioners seem to have standardized on 20 day historical volatility as the appropriate recent look back period. In order to get a preview of how the 20 day HV is developing, I spend a fair amount of time looking at 10 day historical volatility.

The chart below shows the SPX, the VIX, and 10 day historical volatility in the SPX going back to the beginning of November, just prior to the SPX bottom and the last big VIX spike. Note that since mid-December the VIX has been above the 10 day HV for all but five days, the period stretching from January 28^th to February 2^nd. With the relatively gentle movement in the SPX over the course of the past few days, the SPX 10 day HV has once again moved dramatically below the VIX, closing at 31.13 yesterday.

Unless volatility picks up dramatically, I would expect to see the VIX start moving in the direction of the SPX 10 day HV, quite possibly returning to the 30s for an extended stay, starting as early as next week.

[source: VIX and More]

Why Is There So Little Volume in the Most Recent Direxion ETFs?

It seems as if every day trader I know has fallen under the spell of the leveraged firepower of the Direxion triple ETFs. Oddly, only the first batch of ETFs that were rolled out in November have caught fire. These include the familiar tickers like FAS, FAZ, TNA, TZA, BGU, BGZ, ERX and ERY.

The most recent group of ETFs, which I discussed in Direxion Triple ETFs Add New Horses to Stable, has attracted considerably less interest. Even though they were launched at the end of December, only two of the six ETFs, EDC and TYH, have surpassed the 100,000 single day volume mark and TYH just grazed that bar, with a high volume mark of 101,900. In the chart below, a snapshot taken just past the halfway point of today’s session, the six new ETFs can be seen floundering at the bottom.

Juice is not the problem, as emerging markets (EDC and EDZ) and technology (TYH and TYP) are consistently among the most volatile corners of the market.

The comments on yesterday’s semi-rhetorical question we excellent. Let’s see what sort of explanation the collective wisdom can come up with today.

[source: Yahoo]

When the Banks and the SPX Diverge, What Should the VIX Do?

A simple rhetorical question: what should the VIX be tracking, the SPX or the banks?

I raise this issue because for most of today’s session, the S&P 500 index was flattish, while the VIX was down several percentage points. At the same time the financials in general and the banks in particular were struggling mightily. As the chart below shows BKX, the Keefe, Bruyette & Woods banking index, which spent the bulk of the day down 6-8%.

Does the fact that the VIX fell 5.4% while the banks sold off (-5.6%) and the SPX rose (1.6%) mean that traders of SPX options are not concerned about the future of the banks? I find this hard to believe. I would love to hear some comments on this one?

[source: BigCharts]

SPX Symmetrical Triangle Pattern Approaching Breakout

In the chart below, I show a symmetrical triangle (dotted green line) that has formed in the S&P 500 index over the course of the past 2-3 months. As the triangle narrows, the potential for a breakout move – in either direction – increases substantially.

Classical technical analysis categorizes symmetrical triangles as continuation patterns, which suggests that the most likely direction of the breakout move is down. With the SPX currently hugging the bottom of the pattern and needing to gain about 1.7 points each day just to stay above the line, treading water is not good enough. Instead, the markets will need a significant bounce to get some breathing room.

I still think a significant bounce is a strong possibility, but time is running low…

[source: StockCharts]

VXX Volume Easily Surpasses Friday’s Mark

If Friday was an “unqualified success” for VXX, the iPath S&P 500 VIX Short-Term Futures (1 month) ETN, then today has to be considered even more of the same. The new VIX ETN has already exceeded Friday’s impressive first day volume total, with 220,517 shares traded at after 1:15 p.m. ET, with two and three quarter hours of trading still to come.

For the most part the bid-ask spread for VXX has been in the 0.02 to 0.18 range, sometimes higher and sometimes lower. I consider this acceptable for short-term trading of a security priced in the vicinity of 100. Market depth is difficult to gauge at this stage but may be a little on the thin side. As news of the success of VXX spreads, however, I expect liquidity issues to be resolved fairly quickly.

As was the case on Friday, volume in for VXZ, the iPath S&P 500 VIX Mid-Term Futures (5 month) ETN is running at about one third the rate of its near-term sibling.

Bullish Signal from Global Volatility Index

VIX and More’s proprietary Global Volatility Index has been a big hit since I unveiled it in November, which means that I will periodically update it and flag interesting developments in this space going forward.

At the close of Friday’s session, the difference between the Global Volatility Index and the VIX had narrowed to its lowest level since October and the premium percentage (the GVI divided by the VIX) was at its second lowest level ever. I consider this to be a bullish signal.

In the chart below, I have marked the previous highs and lows in the premium percentage with red and green arrows. The red arrow marking the high comes from the first week in December 2007 and was an excellent opportunity to sell or get short. The green arrow from late October was an early bottom. In the months that have followed, the Dow Jones World Stock Index has largely marked time. While this indicator is still relatively young and untested, I consider Friday’s second lowest reading to reinforce or confirm the October buy signal.

As always, caveat emptor.

[source: VIX and More]

Historical Options Data

Lately I have received several requests to help identify sources of historical options data. First keep in mind that online brokers specializing in options (such as thinkorswim and optionsXpress) often make a surprising amount of options data available to account holders.

That being said, the two data providers that I most often find myself recommending are (in alphabetical order):

• IVolatility.com
  
  
• Market Data Express – a sponsor of VIX and More that is currently offering free registration for those who click on the “Get More Data” button in the advertisement at the upper right hand corner of the blog