VIX Spikes Above Bollinger Bands

Yesterday’s 12% jump in the VIX lifted the volatility index to 13.8% above its 10 day simple moving average. As noted on a number of occasions here, when the VIX is at least 10% above its 10 day SMA, this is usually a good time to initiate a short-term mean reversion play and go long the SPX and/or short the VIX.

While I have not discussed it as often in this space, another useful VIX mean reversion signal can be derived from using Bollinger bands to determine when the VIX is overextended and likely to snap back. The simplest approach is to monitor when the VIX closes above the upper band of a 20 day, 2 standard deviation lookback period.

The chart below uses the standard 20 day, 2 standard deviation Bollinger bands to evaluate the moves in the VIX during the past year. Note that following the largest sustained VIX spike ever – during September and October of last year – it has been relatively rare for the VIX to close above the upper band. There was one instance of a close well above the upper band in January that marked a short-term bullish move, then there were two closes above the upper band at the end of February and the beginning of March that preceded the market bottom and strong bounce.

By historical standards, yesterday’s close 4.7% above the upper band is a fairly substantial breach and suggests a short-term bullish bias. Given the narrowing Bollinger band width (bottom study), however, it obviously took a much smaller move to penetrate the upper band than it did in January, when the VIX was hovering around 50.

It seems as if lately everyone has been looking for a pullback. The big question is how much of a pullback it will take to satisfy the bears and how soon it will be until the buy-on-the-dip mentality begins to dominate again.

For some related posts, try:

• The VIX and Bollinger Bands
• More Questions About Bollinger Bands
• Bollinger Bands: Why 20 Days?
• Bollinger Bands and the Standard Deviation Setting
• Charting the VIX with 10 Day SMA Envelopes

[graphic: StockCharts.com]

JunkDEX Falls 11% in First Two Hours of Trading

I was not expecting to talk about the JunkDEX for the third day in a row, but since I have received several requests, I will run with this theme for another day.

Today the JunkDEX is showing an acceleration of yesterday’s 7.2% move downward. As of 11:30 ET, the JunkDEX is down a little more than 11%, with American International Group (AIG), Fannie Mae (FNM) and CIT Group (CIT) all down about 15% each.

Based on the large trading volumes, Sunday’s call of an impending blow-off top is looking as if it may be coming to fruition.

For some related posts on junk financials and the JunkDEX, try:

• JunkDEX Tracks Speculative Frenzy in Junk Financials
• JunkDEX Component Performance

[Disclosure: short AIG at time of writing]

JunkDEX Component Performance

I am delighted to see that JunkDEX Tracks Speculative Frenzy in Financials and the JunkDEX itself appear to have hit a nerve and have generated such positive feedback.

To some extent, one could argue that the selection of the individual components of the JunkDEX was done in a somewhat arbitrary fashion and consequently, the performance of the index is somewhat biased by the hand-picked issues that tell a particular story.

I already mentioned the exclusion of Freddie Mac (FRE), largely because the company’s business, financial history and stock performance is so similar to that of Fannie Mae (FNM). I also looked at Lehman Brothers (LEHMQ), which gave us the LEHVIX, among other memories. LEHMQ was up 200% on Friday and is up another 50% so far today. I even toyed with the idea of General Motors (MTLQQ), but as both of these issues trade on the pink sheets, I did not want to venture into that netherworld.

For some historical context, I thought it would be helpful to provide some individual component performance charts for the JunkDEX. The first chart covers the full span of the JunkDEX, dating back to the beginning of 2009. It shows particularly strong performance on the part of Fannie Mae and American International Group (AIG):

The second chart reflects performance in each of the five components over the course of the last five weeks. Given the relatively short time frame for this data, I find the percentage changes to be even more interesting. While FNM and AIG are still the top performers, both Citigroup (C) and CIT Group (CIT) have doubled during this period. Bank of America (BAC), which is weighted down by a market cap of $153 billion, is considerably less nimble, yet still has a gain of 37% in the past five weeks:

In today’s trading, AIG is down 11.5%, FNM is down 5.4% and only CIT is showing a gain.

[graphics: StockCharts.com]

[Disclosure: short AIG at time of writing]

Chart of the Week: JunkDEX Tracks Speculative Frenzy in Junk Financials

Back in September 2007, when I thought the markets were a little too frothy, I created a list of Overripe High Fliers. A few weeks later, in From Overripe to Vulnerable? I took the current list of 14 overripe high flier stocks that had been drawing a great deal of speculative attention into something I called the OHFDEX – an index based on those overripe high fliers.

Not only was the timing of the OHFDEX impeccable, but the post became so popular that it spawned a number of follow-up posts, including, OHFDEX One Year Later.

In the spirit of the original OHFDEX, I have been watching closely the recent speculative frenzy in some stocks that have come to be known as “junk financials.” These are financial firms that were the recipients of government bailout funds during the financial crisis and now sell at valuations substantially below 2007 levels. They include American International Group (AIG), Fannie Mae (FNM), Freddie Mac (FRE), Citigroup (C), CIT Group (CIT) and Bank of America (BAC). In the last few weeks, these stocks have routinely accounted for 30% or more of the total volume on the NYSE and on Friday alone the group of six traded 2.53 billion shares.

While I find the transition from risk-averse behavior to risk-tolerant behavior on the part of investors to be an important step in the healing process, the recent headlong rush into risk-seeking behavior has me more than a little concerned. How healthy can the markets be when speculation in six companies that were all but bankrupt a few months ago now accounts for one out of every three shares traded each day?

In order to track the speculative interest in junk financials, I have created what I am calling the JunkDEX, which consists of equally weighted positions (as of 1/2/09) in AIG, FNM, C, CIT and BAC (I elected to omit FRE due to the strong similarities with FNM.) I scaled the JunkDEX so that it had the same value as the SPX at the beginning of the year. As this week's chart of the week below shows, the JunkDEX led the S&P 500 index down from January through March, bottomed two days earlier and rallied impressively through the middle of May. From May through early August, the JunkDEX lagged the SPX significantly, before spiking dramatically during the past 3 ½ weeks.

The JunkDEX looks as if it may be approaching a blow-off top. If this turns out to be the case, I expect it will signal an imminent top in the broader markets, just as the OHFDEX did.

Going forward, I will keep an eye on speculative activity in the junk financials and in the JunkDEX for clues about the sustainability of the recent bull leg. I will update the performance of the JunkDEX, as appropriate and suggest that traders treat these stocks with extra caution, whether long or short.

[graphic: VIXandMore]

[Disclosure: short AIG at time of writing]

The Other Side of Fear and Panic

Joshua Brown at The Reformed Broker has a nice piece out this morning (hat tip, Trader Mike) with the playful title of The Five Stages of Panic Buying. Brown illustrates each of the five stages with quotes from through the investment management world and in so doing has reconstructed something of a psychological history of the current bull market. Both bulls and bears are encouraged to click through to get a chuckle out of what has been going on in the head of investors for the past 5-6 months.

The underlying theme of all five stages is that on Wall Street, where annual bonuses are typically doled out based on performance relative to a benchmark, investment managers loathe the idea of falling behind that benchmark early in the year and having to play catch-up for the balance of the year. Particularly in a year when the market starts down then reverses sharply to the upside, one would expect that a large majority of investment managers would find themselves chasing performance, becoming more aggressive and taking on more risk in order to reel in the benchmark.

Of course, panic buying is not the flip side of panic selling. Panic buying favors the use of more derivatives, more leverage, more beta and less cash. It shows up on charts as aggressive buying on the dip, the failure of stocks to retrace earlier gains, etc. and is part of the reason why the 10 day rate of change (ROC) in the chart below has yet to fall below -5 (%) since the rally began.

What I find particularly interesting is that I believe panic buying is more likely to lead to crowded trades and ultimately to panic selling. There have not been many days in which we have seen big drops in the SPX and there has certainly been no extended weakness in stocks since the March bottom, but I suspect that when the market finally does turn, those same panic buyers will be quick to lock in gains in hopes of keeping pace with or finally overtaking the appropriate benchmark.

So…if we have many panic buyers who have been chasing performance with long positions of questionable underlying value, then the potential for some high volatility trading in the next month or so may be higher than recent stock market activity has led many to believe.

[graphic: StockCharts]

The Recent Treasury Auction Brouhaha

In yesterday’s An Introduction to Treasury Auctions, my intent was to provide some background information on Treasury auctions that might be appropriate to get an equity-centric investor up to speed on the basics.

I know from personal experience that it is easy to define one’s investment universe as consisting entirely of stocks, but if we have learned anything in the past year, it is that erecting artificial boundaries to one’s investment knowledge dramatically increases the risk of getting blindsided in any asset class.

So with the introduction out of the way and with the considerable encouragement of a number of readers, let me turn to some interesting recent developments that have created quite a stir in the bond circles.

The issue of foreign demand for U.S. debt has loomed large during the course of the financial crisis. One of the early flash points was the deterioration and eventual government bailout of Fannie Mae and Freddie Mac. At that time, approximately 10% of China’s GDP was invested in bonds issued by Fannie Mae and Freddie Mac, which was probably the reason why Treasury Secretary Henry Paulson felt the need to explain:

“Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe. [emphasis added]”

As noted yesterday, China and Japan each account for about 1/3 of the U.S. Treasury debt held by foreign nations. Since the beginning of the financial crisis, there have been rumblings that interest in U.S. debt may be waning in the Treasury’s two largest customers – an issue that was summarized nicely by Keith Bradsher of the New York Times at the beginning of the year in China Losing Taste for Debt from U.S. The most recent data available show that China, the largest customer of U.S. Treasury securities, reduced its holdings from $801.5 in May to $776.4 in June.

The issue became a little stickier when the Fed decided to change the manner in which it reports data from indirect bidders on June 1^st. In Is Foreign Demand as Solid as It Looks? Min Zeng of the Wall Street Journal claimed that the new reporting standards which expanded the definition of indirect bidders made it more difficult to determine the level of foreign demand.

Skipping ahead to the punch line, the most interesting recent claim of note comes from Chris Martenson, whose The Shell Game – How the Federal Reserve Is Monetizing Debt makes the case that the Federal Reserve is using a custody account to enable foreign central banks to swap agency debt for Treasury debt. If this turns out to be the true, it will undoubtedly have some very interesting implications.

For those seeking out additional background and context, the following will likely be of interest:

• The Fed Buys Last Week’s Treasury Notes (Chris Martenson)
• The Fed’s UST-POMO Pyramid Scheme Exposed (Zero Hedge)
• Open Market Operations and Statistics (Zero Hedge)
• Monetizing the Debt: Disinformation in the Blogosphere (John Jansen)
• Treasuries Rally on Solid Demand for 7-Year Auction (Deborah Lynn Blumberg)
• “Lending” a Helping Hand (Brian Benton)
• Double Secret QE (Tracy Alloway)

An Introduction to Treasury Auctions

It remains to be seen whether the growing U.S. Department of the Treasury auctions will be a relatively quiet sideshow or eventually take the center stage in the ongoing financial crisis. As the number of potential disaster scenarios continues to shrink, one subject that I see receive surprisingly little play in the blogosphere is one of the few remaining potential disasters: the auction of U.S. debt.

The concern is that as the U.S. debt grows, so does the volume of Treasury debt for each auction. The big fear is that at some point the supply of U.S. debt may begin to outstrip the demand. At the moment, China and Japan account for about 2/3 of all foreign holdings of U.S. Treasuries; any plateau in the demand for U.S. debt from these two nations might necessitate higher interest rates to stimulate demand and could send potentially traumatic shock waves throughout the economy. This is the disaster scenario. So far, I am happy to report, demand for Treasuries has been robust and yields have remained at very low levels.

The U.S. Treasury auctions a mixture of Treasury Bills (with maturities from 4 weeks to 52 weeks), Treasury Notes (from 2 to 10 years) and 30-Year Treasury Bonds. The T-Bills are auctioned on what is largely a weekly cycle, with the typical pattern seeing the 13-week and 26-week T-Bills slotted for Mondays and the 4-week and 52-week T-Bills on Tuesdays. Given the frequency of these T-Bill auctions and the relatively low demand from foreign central banks, the T-Bill auctions are probably the least important auctions in terms of being able to gauge market sentiment and the strength of foreign demand.

The more important auctions are of the Treasury Notes, where the 10-Year Note has become the de-facto benchmark for U.S. long-term debt. Treasury Note auctions are best understood as occurring on a monthly cycle, with the 3-Year and 10-Year Notes typically auctioned on Tuesdays and Wednesdays during the second week of each month and the 2-Year, 5-Year and 7-Year Notes typically auctioned off on Tuesdays, Wednesdays and Thursdays of the last week of each month.

The 30-Year Bond and Treasury Inflation Protected Securities (TIPS) are a much smaller part of the Treasury refunding process and are subjects for another post.

The results of Treasury auctions are announced at 1:00 p.m. ET (see Announcement & Results Press Releases) and contain three particularly important pieces of information:

1. Yield
2. Bid-to-cover ratio
3. Percentage of indirect bidders

In short, the yield determines the cost of the debt refunding and/or the price sensitivity of the bidders. The bid-to-cover ratio is simply the total dollar amount of the bids tendered by the total amount of the securities being auction and reflects demand relative to supply. Finally, the percentage of indirect bidders is used as a proxy for demand from foreign central banks, as indirect bids are bids of significant size that do not go through the primary dealer community.

Going forward, investors should keep an eye on the Treasury auctions, particularly on the demand for U.S. Treasury Notes. Should yields start rising, bid-to-cover ratios start falling and participation by indirect bidders begin to decline, then we may have the beginnings of a new kind of debt crisis on our hands.

For additional information on Treasury auctions, try:

• Tentative Auction Schedule of U.S. Treasury Securities
• Recent Results for Notes, Bonds and TIPS Auctions
• Today’s Auction Results
• Recent Results for Bill Auctions
• Announcements & Results Press Releases
• Major Foreign Holders of Treasury Securities
• Who Buys Treasury Securities at Auction?

For some VIX and More posts on TIPS, readers may wish to check out:

• Treasury Inflation-Protected Securities and Inflation Expectations
• Chart of the Week: TIPS Breaking Out

Bloggers on Volatility

In the last day or so I have noticed quite a few excellent posts on volatility and related subjects from various corners of the blogosphere. Some of my favorites, in case anyone missed them:

• Moderators of Daily Follow Through MR: Volatility (Part 1 of 3) (David Varadi, CSS Analytics)
• Volatility Tracker: Skewed Returns (Jared Woodard, Condor Options)
• Relative Put/Call Reading on Friday is Lowest Ever (Rob Hanna, Quantifiable Edges)
• Mmmm BEP (Adam Warner, Daily Options Report)
• Futures Options – A Bit Different, Futures Options - Part 2, Futures Options Part 3 (Sigma Options)
• Strangling Gold (Tyler Craig, Know Your Options)
• A Simplified Method for Buying Portfolio Insurance (Mark Wolfinger, Options for Rookies)
• Historical Data Randomization Using the Frequency Domain (Preview) (Kevin, Quantum Fading)
• Producer Price Index Volatility Going Back to 1930, 1947 (BLS) (Distressed Volatility)

SPX at Post-Lehman Fib Retracement Target of 1035-1037

There have been several posts (see below) in this space that have addressed the issue of Fibonacci retracements in the S&P 500 index. In the dialogue, I have been a proponent of using a post-Lehman high in conjunction with the March low to arrive at a set of post-Lehman Fibonacci retracement numbers. Depending upon whether one uses just the real bodies of the candlestick (open and close) or includes the shadows (adds intraday highs and lows), the 61.8% retracement of the post-Lehman high falls in the range of 1035 to 1037.

A short while ago, the SPX established a new high for the year of 1035.82, which puts it right at the post-Lehman Fibonacci retracement target price, as shown in the chart below, which uses relatively unusual two-day candles.

I have been waiting patiently for two or more consecutive days of weakness and/or a 5% pullback from the highs to open up some aggressive short positions. With the Fibonacci retracement target hit, I am now more likely to start to scale into some short positions early, assuming we start to see some sort of meaningful weakness in stocks this millennium…

For some related posts on the SPX and Fibonacci retracements, try:

• Dueling Fibonaccis for the SPX
• SPX and Fibonacci Resistance at 966
• Open Thread: Do Fibonacci Retracements Work?

[source: FreeStockCharts.com]

Chart of the Week: BAC Through the Eyes of FreeStockCharts.com

It has been almost six months since I have mentioned banks in the chart of the week, the so it seems as if the statute of limitations for beating dead horses has probably passed and I can talk about Bank of America (BAC) once again.

In the past few weeks, many traders have taken to using Bank of America as their market weather vane, reasoning that as Bank of America goes, so go the banks and as the banks go, so go stocks in general. For the most part, this rationale has held up and anyone who has used Bank of America to gauge the direction of the markets has likely done quite nicely. Of course, investors who were fortunate to have grabbed some BAC shares when the stock was trading below 4.00 have now seen their original investment turn into a five-bagger in just five months.

The chart below also marks the first time I have used a chart from FreeStocksCharts.com on the blog. This relatively new web site is a Worden Brothers venture – which means that it comes from the same people behind the popular TeleChart charting program. Another Worden Brothers product is StockFinder and if you are familiar with StockFinder, then you already know FreeStockCharts.com, which resembles an online incarnation of the former. In the graphic, I have captured some of the drawing tools (which include some fairly exotic tools), available at FreeStockCharts.com. There are also 52 customizable indicators (again, not just the basics), an alert function and other features of interest. In one of the great investing oxymorons, there is also a premium version of FreeStockCharts.com, with fees that are competitive with StockCharts.com.

As a StockCharts subsciber, it would take a great deal for me to switch to another charting program, but FreeStockCharts.com certainly looks like a compelling alternative at first blush. At the very least, it can provide a different color scheme and set of indicators for the blog…

For some related posts, try:

• StockCharts.com Charts on the Blog
  
• Chart of the Week: Bank of America Teeters
• Chart of the Week: Four Good (?) Banks
• Good Luck Getting a Mortgage Here…

[source: FreeStockCharts.com]

Options Expiration Weeks and the March to August Bull Market

For a number of reasons, the options expiration cycle can be extremely difficult to trade. One of the problems with options expiration week is that the forces acting on stock prices are often much different this week than during other weeks, often ignoring underlying existing trends, but sometimes magnifying them.

A good rule of thumb is that the week before options expiration is most likely to be bullish and the week after options expiration is most likely to be bearish. On average, options expiration week is less volatile and more directionally neutral than these other two weeks.

In the table below, I looked at data since the March 6^th low and found it interesting that the week before options expiration has been the most bullish of the three expiration weeks, with the week after options expiration the second most bullish, by a small margin. Options expiration week itself has been relatively flat, particularly when compared to the other two weeks.

My knee-jerk explanation for this is that stock movements during options expiration week are more likely to be random and out of synch with underlying trends. As a result, during options expiration week, stocks frequently underperform in bull markets and outperform in bear markets.

For some related posts, try:

• VIX Performance During the Options Expiration Cycle
• Trading Options Expiration Days
• Another Winner from Jeff Augen

Say Hello at the San Francisco MoneyShow Tomorrow

Since I started this blogging adventure in early 2007, I have had the pleasure of developing relationships with quite a few people across the globe. So far I have had an opportunity to meet only a few of them in person, but that will start to change in the coming year, as I expect to attend a number of industry functions. Tomorrow I will be at the local San Francisco MoneyShow at the San Francisco Marriott and will be at the greenfaucet booth (#616) from noon until 1:30 p.m. If you are at the event and want to stop by and say hello, I am looking forward to putting some faces behind the names. If you are on the fence about coming, registration is free (register here) and between the speakers and the exhibitors, there is sure to be something in the investment world that is of interest to you.

Of course, if you can’t make it to San Francisco, feel free to drop me a note any time. While not always successful, I do my best to stay current with email and comments on the blog.

[photo of San Francisco from Ring Mountain, Tiburon, CA]

The Sideways Play

The more dogmatic bulls and bears get about the markets, the more I usually begin to pay attention to the possibility of a sideways market. As is often the case, both bulls and bears can make compelling arguments to support their position – and even back them up with a convincing set of facts.

From a technical perspective, while the SPX has bounced more than 50% off of its bottom, there has been very little in the way of pullbacks during the ride up.

So here we sit at SPX 1004, with the major averages just a little below their recent highs and August SPX options set to expire at the open tomorrow. Still, it has been nine sessions since the SPX made its 2009 high of 1018. Finally, while volatility has been declining, the VIX seems to have found a floor in the 24-25 range.

With these factors, I am looking hard at selling some SPX straddles. The charts below show that a single contract SPX September 1000 short straddle (top chart) has a maximum potential profit of $5000, with a profit zone between 950 and 1050. Traders who might be interested in the SPX October 1000 short straddle (bottom chart) have a maximum potential profit of another 50% or so ($7530) and a 50% wider profit zone (from 925-1075) as well.

Short straddles will perform best when markets move sideways and volatility (vega) declines.

Of course, when short trades go wrong, they can get ugly quickly, so anyone looking to enter in a short straddle should expect monitor this trade closely and have all manner of exit strategies mapped out in advance.

Traders who are more risk averse will certainly be interested in checking out butterfly plays instead of straddles.

For additional posts on these subjects, readers are encouraged to check out:

• Straddles vs. Iron Butterflies
• One Approach to Volatile Sideways Markets
• The Options Opportunity Matrix

…and the two part SPX short straddle case study:

1. Is the SPX Going to Stick Close to 900?
2. SPX Straddle Case Study Update

[graphics: optionsXpress]

The Gap Between the VIX and Realized Volatility

Since making an all-time closing high of 80.86 on November 20^th 2008, the CBOE Volatility Index (VIX) has been declining in the direction of its historical mean of 20.22. While the initial drop in the VIX took it rapidly from 80 to the 40-50 range, it took some time before investors began to gain confidence that the March lows in stocks were going to be the bottom. Once the consensus began to build around the likelihood of a bottom and a historic buying opportunity in stocks, the VIX began a steady descent that has taken it all the way down to the mid-20s.

As the chart below demonstrates, as rapidly as the VIX (red line) has been able to fall, it has not managed to keep up with the decline in realized volatility. The chart records the closing VIX value for each day as well as the 21-day realized volatility (dotted green line) that results from calculating 21-day historical volatility 21 trading days into the future. These calculations allow an options buyer or seller to determine the extent to which the VIX (which looks forward 30 calendar days) accurately predicted the realized volatility that occurred during the next 21 trading days or approximately 30 calendar days. The differential (VIX-RV) is plotted as the blue area.

One of the key takeaways from the chart is that at least during the last 2 ½ years, the VIX frequently has been a poor estimator of future volatility. During the October 2008 portion of the financial crisis, the VIX often underestimated future volatility by 30-40 points. Since November, however, the VIX has been consistently overestimating future volatility. In fact, not since February 27^th has the VIX expectation of future volatility turned out to be lower than realized volatility 21 days hence.

In other words, if you had been selling SPX options every day since the beginning of March, the dramatic decrease in implied volatility would have almost guaranteed that every day would have been a winning day.

[While I have generally avoided using the term “realized volatility” here, it is synonymous with historical volatility, statistical volatility and actual volatility. All these terms reflect the conventional way of calculating the volatility of a series of changes in price, which is essentially done by taking the natural log of the ratio of daily price changes relative to the mean value for the data series. To the extent that I can avoid confusion, I will try to standardize on using ‘historical volatility’ when looking backward from a specific date and ‘realized volatility’ when looking forward from a date in which there are more recent historical data from which to derive the calculations. For the record, there are actually several ways to calculate historical volatility and one of these days I will finally get around to a series of posts on historical volatility, starting with the calculations…]

For related posts on this subject, readers are encouraged to check out:

• Historical Volatility Continues to Plummet
• Extremes in the Spread Between the VIX and the 20 Day Historical Volatility in the SPX
• On Measuring Volatility

CWB: A New(ish) Convertible Bond ETF

I have never been a particularly big fan of convertible bonds, but from time to time, these investments can make a good deal of sense.

Launched four months ago (and still qualifying as “new” according to my warped ETF chronograph), the SPDR Barclays Capital Convertible Bond ETF (CWB) is designed to track the price and yield performance of the Barclays Capital U.S. Convertible Bond >$500MM Index.

The table to the right shows the ETFs top holdings as of yesterday’s close, which include a top three of Bank of America (BAC), Freeport-McMoRan (FCX) and Amgen (AMGN). This same snapshot of current top ten holdings can be found here.

Since the launch of CWB on April 16^th, the bull market performance of this ETF has matched the SPX almost step for step, with lower volatility. In the chart below, CWB is represented by the red line, the SPX is in blue, and the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) is shown in green. This chart is an almost perfect illustration of why convertible bond ETFs (or closed-end fund or mutual fund) can be a powerful addition to one’s portfolio. At its best, in bull markets, convertibles have an upside comparable to stocks, with less downside risk. At their worst, which is generally in non-trending markets or bearish markets, the lower yield and expense of owning options that do not appreciate makes convertibles inferior to standard bonds.

Of course, options savvy investors will probably wish to buy their own bond ETF and cherry pick their favorite options plays, but for those who wish to forego a customized approach and stick with an off-the-shelf product, CWB is – for the moment at least – the only ETF which is up to the task.

[graphic: StockCharts]