December Is the Cruelest Month…For the VIX

It seems well-nigh impossible for a December to pass without some sort of movements in the CBOE Market Volatility Index (the formal name of the VIX, for those who may have a short memory) that leave investors scratching their heads. In light of this, it appears I will be responsible for at least one December post reminding investors about the idiosyncrasies of implied volatility and the VIX during the holiday season.

There are a number of ways to look at the typical holiday swoon in the VIX, which I have labeled (the holiday effect or calendar reversion) for easy tagging and backtracking. From a strict fundamental perspective, the biggest change during the December/January holidays is fewer trading days, which means a shorter runway for stocks to depart for some unusual destinations. The other big factor is one of seasonality, specifically the tendency for December to be a bullish month for stocks.

I have chronicled how these factors influence the VIX and the strange prints they sometimes leave on the charts in posts from previous years (see links below.)

This year I am offering a chart which shows that in any given year, there is about a 40% chance that the VIX will make its annual low in December and as I discussed last year in VIX and the Week Before Christmas, the bottom usually comes in the last half of the month and most often just before Christmas.

In three trading sessions the VIX is already more than 20% off of its 30.91 close from last Thursday. It seems rather far-fetched to think that the VIX will plummet all the way below the current 2011 low reading of 14.27 from April 28^th of this year (a date that is provisionally included in the chart below,) but stranger things have happened.

Even if you think the European sovereign debt crisis will see several more eruptions before the end of the year, don’t be surprised if the VIX is sleeping with the fishes for the next week or two.

Related posts:

• VIX and the Week Before Christmas
• Chart of the Week: Historical Volatility Plummets in Seasonal Swoon
• VIX Holiday Crush
• Chart of the Week: VIX Support
• VIX Put Matrix Offers Glimpse of Expected Future
• The Incredible Shrinking VIX
• Where Will the VIX Bottom?
  

Disclosure(s): none

[source:  CBOE, Yahoo]

The Low Fear Selloff

Steven Place of Investing with Options has a video post up this morning, Options Market Does Not Care About Selloff, in which he discusses how the implied volatility in various asset class volatility indices (VIX, GVZ, EVZ) are showing a very muted reaction to today’s selloff in stocks.

As noted here previously, the VIX generally moves about -4x in percentage terms the direction of the SPX. Mondays generally see a slightly larger move in the VIX relative to the SPX (usually an incremental 0.5% - 1.0% increase over Friday’s close) due to calendar reversion or the weekend effect, so today one would expect to see the VIX moving at least 4x in the opposite direction of the SPX.

In fact, as I type this the SPX is down about 1.9% on the day and the VIX is up only 3.9% -- so the VIX is about half as sensitive to changes in the SPX that is typical for a Monday trading session.

This is not to say that investors are oblivious to the risk that remain in Europe (and elsewhere) or that today’s move is just a head fake by stocks, but it does mean that the consensus expectations for immediate downside risk are quite low.

Santa may pay a visit after all, assuming he manages to survive all the austerity measures that I am certain his government has saddled him with…

Related posts:

• VIX Reflecting Skepticism About Rally
• VIX Suggests Investors Don’t Believe Rally Is Sustainable
• Fearogram Maps Recent VIX Complacency
• How Fearful Were We Last Week?
• SPX-VIX Daily Correlation
• Performance Implications of VIX and SPX Divergences
• More Thoughts and Numbers on the SPX-VIX Correlation
• High Positive Correlation Between VIX and SPX Often Signals Market Weakness
• The Calendar Effect and Time Decay

Disclosure(s): none

Aggregate View of U.S. Data vs. Expectations

Yesterday I posed and (to some extent) answered the question, How Good Has the U.S. Data Been Lately?

Today I have aggregated the performance relative to expectations across five groups of economic activity (manufacturing/general, housing/construction, employment, consumer and prices/inflation) and present those data and the S&P 500 index for the past two years.

As the graphic below shows, both the data and the SPX has retraced about half of the decline since the late April (stocks) to early May (economic data) peaks.

Looking at the chart, one could certainly make the case that data underperformed stocks from April to September, but has been outperforming stocks for the last 2 ½ months.

While conventional wisdom says that stocks lead economic fundamentals for 6-9 months, this graphic does not support that idea. Instead, it will be interesting to see which of the two assumes a leading role now that at least some of the European angst appears to be in the rear view mirror.

[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:

• How Good Has the U.S. Data Been Lately?
• Economic Data Not Supporting Gloom and Doom Forecasts – At Least for Now
• Economic Data Relative to Expectations and Stock Prices
• Continued Lackluster Data vs. Expectations
• Economic Data Frozen Until Next Thursday
• More Upticks in Economic Data vs. Expectations
• Economic Data Trends Improving
• Chart of the Week: Updated Economic Data Trends
• Economic Data Trends in Advance of Nonfarm Payrolls
• Trends in Economic Data Relative to Expectations

Disclosure(s): none

[sources: various]

How Good Has the U.S. Data Been Lately?

At some point investors are going to have to change their watches back from Central European Time to Eastern Time (or Central Time if you are an options trader) and pay more attention to what is going on inside the borders of that sometimes overlooked nation just south of Canada.

Whenever that time comes, the first question on the agenda on the minds of most investors will be whether the relatively robust economic performance (at least by current global standards) will be able to continue. Earlier this week, in Global Manufacturing Recession or Noise? EconomPic raised the question of whether the U.S. and a handful of emerging market economies would be able to lift the global economy up or whether Europe and the Pacific Rim nations would end up dragging down those few economies that are currently thriving.

I do not have an answer to that question at this point in time, but I do believe the answers are most likely to come out of U.S. economic performance relative to expectations, which I have been tracking in some detail for the past two years. The graphic below shows how the United States has been faring relative to expectations in five groups (manufacturing/general, housing/construction, employment, consumer and prices/inflation) since the beginning of 2010.

The graphic below shows a definite upturn in positive surprises across all categories during the past 2-4 months. Should these trends continue, it bodes well for global activity and for stock prices as well – especially if the European disaster discount can be marked down.

Readers who are interested in more information on the details of the economic 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:

• Economic Data Not Supporting Gloom and Doom Forecasts – At Least for Now
• Economic Data Relative to Expectations and Stock Prices
• Continued Lackluster Data vs. Expectations
• Economic Data Frozen Until Next Thursday
• More Upticks in Economic Data vs. Expectations
• Economic Data Trends Improving
• Chart of the Week: Updated Economic Data Trends
• Economic Data Trends in Advance of Nonfarm Payrolls
• Trends in Economic Data Relative to Expectations

Disclosure(s): none

[sources: various]

Taking Profits in VIX Options (and ETPs)

Two hours into today’s session, the trading idea I mentioned yesterday, going long VIX puts, is doing quite well. The VIX Dec 27.50s are up more than 50% and the Dec 30s puts have advanced about 45%.

One question that I believe is much trickier with VIX options than options for most other securities is when and how to take profits. A large reason why taking profits in VIX options has an extra layer of complexity and difficulty is due to the mean reversion tendencies of volatility in general and the VIX in particular.

Another potential complicating factor regarding the management of VIX options positions has to do with their underlying. I hope that by now readers of this blog have had it drummed into their head that the VIX futures are the best proxy for the underlying in VIX options, not the cash VIX or VIX index, which is the VIX that is most often quoted in the media. Anyone holding positions in VIX options – and VIX ETPs for that matter – should be monitoring the VIX futures.

Looking at the changes in the first two hours of trading, one can see the typical pattern in which the front month (December) VIX futures (-6.3%) are moving about 80% as much as the cash VIX (-7.9%), with the second month (January) futures (-4.4%) moving about 56% of the cash VIX. This is right in line with historical norms. For an additional data point, VXX, which is a blend of front month and second month VIX futures, is down about 4.7%, which makes sense in that hold a disproportionate amount of front month futures at this point in the options expiration cycle.

So what does this all mean for taking profits in VIX options?

First, I cannot overstate how important it is to watch the VIX futures and understand how they move in relation to the cash VIX.

Second, because the VIX has a tendency to mean revert and thus often reverse recent sharp moves in either direction, it is important to take at least partial profits when one is the beneficiary of a significant favorable move in volatility. I like to take profits in 25% or 50% of my position, for instance, if my VIX options appreciate by 50%.

Third, keep in mind that the long VIX puts mentioned above are still out of the money and have no intrinsic value. As a result, they are subject to significant time decay (theta) each day and therefore will lose value if there are no additional favorable moves in volatility.

The bottom line is that harvesting VIX profits can be a challenging task and should be thought of as part art and part science. One only has to look at the many steeple-shaped VIX spikes to appreciate just how fleeting large profit opportunities in VIX options can be.

Besides, who knows what the next rumor out of Europe will be and how much the masses will panic or unpanic.

Related posts:

• VIX Puts Looking Attractive
• VIX Under 30 Five Days in a Row?
• Forces Acting on the VIX
• A Conceptual Framework for Volatility Events
• The Convergence of VIX and VIX Futures at Expiration

 

[source: LivevolPro.com]

Disclosure(s): short VXX at time of writing; Livevol is an advertiser on VIX and More

VIX Puts Looking Attractive

A lot can happen to the financial markets in the course of the next day or so and by my unofficial reckoning, quite a few of those are not just scary, but could have a 2008 flavor to them.

With the VIX at 30.60, implied volatility certainly is high, but not as high as it has been in recent months. This sounds like it may be a good time to buy some VIX calls, but I have a contrarian thought. VIX puts are relatively overlooked right now. The ask for the VIX Dec 27.50s is 1.00 and for the Dec 30s it is 2.30. Should we see a post-summit volatility crush, then even with some of those bearish scenarios, it is possible that the VIX will be declining as the anxiety over event volatility is behind us.

I like to say that the best time to buy VIX calls as portfolio protection is when the VIX is cheap, not when you think you need it. The corollary to this is that a good time to buy VIX puts is when everyone else is snapping up the calls at inflated prices.

Keep in mind that VIX options have their own options cycle. This month they expire on Wednesday the 21^st and the last time they can be traded is on Tuesday the 20^th.

Related posts:

• VIX Under 30 Five Days in a Row?
• Forces Acting on the VIX
• A Conceptual Framework for Volatility Events
• The Convergence of VIX and VIX Futures at Expiration

[source: LivevolPro.com]

Disclosure(s): Livevol is an advertiser on VIX and More

VIX Under 30 Five Days in a Row?

The day is still young and the rumor mill has been eerily quiet so far, but I think it is worth noting that the VIX appears ready to make it five consecutive days (green box) without breaching the psychologically significant 30.00 level (dotted black line) for the first time since July.

For those keeping score at home – or in the office – it has now been two months (as of yesterday) since the VIX has moved above the 40.00 level.

The chart below shows the path of the VIX so far in 2011, which somewhat resembles either Nessie or a cobra that has reared up and is poised to strike. Call it a Rorschach amphibian, if you will.

I have also added a 10-day rate of change study below the main chart to emphasize that while the absolute level of the VIX is important, the recent rate of change can sometimes be a better gauge of evolving market sentiment.

Given all the uncertainty surrounding a group of 17 diverse actors with very different motivations arising from divergent national agendas, economic interests and domestic political situations, it is reasonable to expect the VIX and other measures of uncertainty to climb going into the end-of-week summit. With four hours in the books, today’s action in the SPX is the tightest single-day range in five months ago. When will the next sabot fall?

[source: StockCharts.com]

Disclosure(s): none

Major Changes to the VIX and More Newsletter and to EVALS

Just a quick update to let readers know that there have been some substantial changes recently to the VIX and More subscriber newsletter and to VIX and More: EVALS.

Back in July I moved the publication of the VIX and More newsletter from Sundays to Wednesdays, due to subscriber feedback. At the time I also dramatically changed the focus of the newsletter content, again based on subscriber feedback, placing an increased emphasis on the analysis of VIX ETPs and ideas about how to trade them.

Two weeks ago I also completely overhauled EVALS so that it now focuses almost exclusively as a model portfolio for VIX ETPs.

Rather than go into the details of these changes in this space, those who are interested in more information are encouraged to check out:

• Changes to Newsletter Place More Emphasis on VIX Exchange-Traded Products
• EVALS Relaunches, Now Focusing on VIX Exchange-Traded Products

A large part of the reason for these changes is to link the newsletter and EVALS more tightly and also have EVALS complement and extend the analysis found in the newsletter.

Thanks to all those who have provided feedback along the way to enhance the value of these two services.

Disclosure(s): none

VIX Reflecting Skepticism About Rally

With the S&P 500 index up 3.4% as I type this and the VIX down 7.8%, it is clear that there is a fairly substantial disconnect at the moment between those who are buying stocks and those who are trading options on the SPX.  The picture is even more dramatic if you look at the upward trend in both the SPX and the VIX since the open.  The graphic below is not ideal for deciphering the relative movements, but the unusually high correlation between stocks and implied volatility is unmistakable when looking at today’s intraday price action.

With the VIX typically moving about 4x as rapidly in the opposite direction of the SPX under ‘normal’ market conditions, it appears as if many investors are skeptical about stocks continuing to rally in the face of ongoing uncertainty about the Europe-driven news cycle.  Following an initial pop, the euro is selling off and after it dropped into the 27s, the VIX now looks content to remain above 28 for the balance of the day, the bullish action in stocks notwithstanding.  One simple explanation:  investors are snapping up options, including put protection, at what look like bargain basement prices.

Related posts:

• VIX Suggests Investors Don’t Believe Rally Is Sustainable
• Fearogram Maps Recent VIX Complacency
• The Week in Fear
• How Fearful Were We Last Week
• SPX-VIX Daily Correlation
• Performance Implications of VIX and SPX Divergences
• More Thoughts and Numbers on the SPX-VIX Correlation
• High Positive Correlation Between VIX and SPX Often Signals Market Weakness

 

[source: FreeStockCharts.com]

Disclosure(s): none

Slicing and Dicing All 31 Flavors of the VIX ETPs

Ten months have passed since the last time I attempted to graphically depict all the VIX-based exchange-traded products. At that time there were 16 such securities; now that number has swelled to 31 and two have closed their doors (IVO and VZZ) along the way.

The graphic below attempts to map the herd onto an x-axis for target duration and a y-axis for leverage. In addition to these important criteria, I have also further delineated the group by identifying the four ProShares ETFs in black (the balance are all ETNs), highlighting the five optionable ETPs with a red O preceding their ticker and flagging the two VIX ETPs that have some non-VIX components (in the form of the S&P 500 index) with a black triangle. For good measure I have identified the issuer with a parenthetical one letter abbreviation (Barclays,VelocityShares, ProShares and UBS).

It is worth noting that earlier in the month S&P and VelocityShares announced several new VIX futures strategy indices that hint at future VIX ETPs, all of which will include both a long leg and a short (inverse) leg.

The VIX ETP space is already an exciting one, with over $2.1 billion in assets and daily volume of over 45 million shares per day. As exciting as 2011 has been in this space, things look to be heating up even more in 2012.

Related posts:

• Now Sixteen Volatility ETPs, Four of Which Are Optionable
• Two More VIX ETNs Make it a Baker’s Dozen
• Impressive Launch for Sextet of New Volatility ETNs from VelocityShares
• VelocityShares Jumping in to VIX ETP Space with Leveraged and Inverse Products
• The Evolving VIX ETN Landscape
• Interesting New Leveraged Volatility ETN Coming from Citi
• Shorting VXX and Long XXV or XIV

Disclosure(s): none

Interview at OptionPundit

Earlier this week, OptionPundit published the transcript of a recent interview: Bill Luby Talks to OptionPundit.

The interview touches on a wide range of subject, but with an emphasis on the VIX and VIX-based ETPs, such as VXX, VXZ, XVIX. As always, VIX futures and the VIX futures term structure are a critical part of this discussion.

Related posts:

• Transcript from Interview with Charles Kirk Now Available
• Appearance on The Option Block
• On Abnormal Returns TV with Tadas Viskanta
• The Education of a Trader

Disclosure(s): long VXZ and short VXX at time of writing

VIX Futures: A Tale of Two Backwardations

After yesterday’s New VIX Backwardation Record post, I thought it might be interesting to compare the VIX futures term structure during the past three months to that of the prior record, which spanned September to December 2008.

The mechanics for graphing VIX futures over time are fairly complicated, as not only do values change daily, but on any day there can be up to ten futures contracts traded, with the front seven months generally being the only actively traded contracts. Of course, the futures roll every month, so the result is a rolling and scrolling array of data.  My efforts at oversimplifying this problem for the purposes of comparing the record 2011 backwardation data and the prior record data from 2008 resulted in the graphic below, which shows the average front month, second month, etc. values for the VIX futures all the way out to the seventh month.  Note the relatively mild in backwardation in 2011 compared to the steep backwardation in 2008. In fact, the 2011 curve is essentially flat from the third month through the seventh month, while the 2008 curve slopes down throughout the entire term structure.

Clearly some of the differences between the shape of the term structure in 2011 vs. 2008 can be attributed to the absolute level of the VIX and the fact that mean reversion expectations were therefore much higher in 2008 than during the past few months.

Students of the VIX may find it interesting that the front two months of the VIX futures briefly reverted to contango in the middle of December of 2008, while both the VIX and the front month VIX futures were still above the 55.00 level.

As it turns out, the VIX futures during late 2008 greatly overestimated the level of the VIX during the first half of 2009. It will be interesting to see if the same can be said for the first half of 2012.

Related posts:

• New VIX Backwardation Record
• VIX Backwardation Commentary
• VIX Term Structure Evolution Over Last Ten Days
• Capitulation in Back Month VIX Futures
• VIX Futures: What Were/Are They Thinking?
• More Volatility + Less Fear = Lower VIX?
• VIX Term Structure Changes Since November 20th
• VIX and the Week Before Christmas
• Short-Term and Long-Term Implications of the 30% VIX Spike

[sources: CBOE Futures Exchange, Interactive Brokers]

Disclosure(s): short VIX at time of writing

New VIX Backwardation Record

This week marks the first time that the front two months of the VIX futures term structure have been in backwardation each day for more than three consecutive months. In fact, the current streak of 68 days eclipses the old record of 63 days that dates to the 2008 financial crisis.

While the backwardation streak is intact for the front two months, when looking at the full VIX futures term structure, the futures curve has reverted to contango five times over the course of the past three weeks. The primary reason that the front two months have remained in backwardation in defiance of the rest of the VIX futures term structure has to do with something I call the “holiday effect” or “calendar reversion.” Essentially, what happened a little over two weeks ago was that the roll from the October front month to the November front month VIX futures, as well as from the November second month to the December second month VIX futures has added some incremental holiday effect backwardation to the front two months. This is due to the fact that the second month VIX futures have an expiration of December 21^st, and these are artificially depressed due to the historically low volatility associated with the holiday season. The impact is being felt by all the short-term VIX futures ETPs that are buying second month (December) VIX futures at artificially depressed levels and selling front month (November) VIX futures as part of the daily rebalancing process.

The graphic below shows the 1.70 point differential between the front month and second month VIX futures. Note that it is not until February 2012 that the term structure starts to flatten out, as investors begin to converge on the idea that the VIX is likely to hug the 30 level for the better part of the first half of next year.

Related posts:

• VIX Backwardation Commentary
• Capitulation in Back Month VIX Futures
• VIX Futures: What Were/Are They Thinking?
• More Volatility + Less Fear = Lower VIX?
• VIX Term Structure Changes Since November 20th
• VIX and the Week Before Christmas
• Short-Term and Long-Term Implications of the 30% VIX Spike

[source: Interactive Brokers]

Disclosure(s): short VIX at time of writing

Shrinking VIX Macro Cycles

Staring at the VIX from the 30,000 foot level, it looks much different than it does from the trenches of daily trading. In the monthly chart below, one can see that from 1990 through 2008, the VIX moved in fairly regular ‘VIX macro cycles’ of 2-4 years in duration, with relatively gentle trends and transition points.

Seen in terms of monthly bars, the financial crisis of 2008 changed the nature of those VIX cycles, with the result that in the last three years the VIX cycles have been short and steep. Unlike the VIX movements through 2008, the more recent VIX movements seem to defy a traditional directional label, so for now at least I have attached a provisional label of “volatility chop” to characterize the VIX movements since the April 2010 low of VIX 15.23. Note that this low coincides with the euro zone approval of $40 billion in bailout funds to Greece. In many respects, the volatility of the last 1 ½ years can be seen as a slow escalation of the European sovereign debt crisis and the evolution of investor opinion regarding the magnitude of the risk and the ability of the euro zone to get ahead of the problem.

Volatility has indeed been qualitatively different since the 2008 financial crisis. You can see the differences on a daily, weekly and monthly basis. Even more interesting for the academician and perhaps problematic for the trader is that distinguishing between volatility regimes is more difficult now that it was for the first decade and a half of the life of the VIX – at least from 30,000 feet.

Related posts:

• Chart of the Week: VIX Macro Cycles and a New Floor in the VIX (9/27/09)
• The New VIX Macro Cycle Picture (4/23/09)
• Recent Volatility and VIX Macro Cycles (10/30/08)
• VIX Macro Cycle Update (3/19/08)
• Was 2007 the Beginning of a New Era in Volatility? (12/24/07)
• VIX Macro Cycles (9/10/07)

Disclosure(s): none

[sources: Stockcharts.com]

Recent Thoughts on the VIX

The VIX and More blog has been quiet for a while as I enjoyed some vacation time and family time. Of course it always seems that when I take some time off the VIX decides to do something extreme and this time around it was no exception.

While I am about to return to writing regularly in this space going forward, I did want to remind readers that no matter how active the blog is, I am always sharing my thoughts on the VIX and volatility on a weekly basis in the VIX and More subscriber newsletter (which is available with a 14-day free trial) and also in more in-depth feature articles in Expiring Monthly: The Option Traders Journal. Back in July I made some changes to the newsletter to place more emphasis on the VIX exchange-traded products and using the VIX futures term structure to enhance trading strategies.

Expiring Monthly continues to be where I publish my extended thinking on volatility. Last week we published the October edition of the magazine and in it was my latest, Investing Implications of the VIX Term Structure. This article actually built on one of my pieces from the September issue of Expiring Monthly: Trading the Expanding VIX Products Space.

Since I last recapped the Expiring Monthly content in May, I have also authored the following articles for the magazine:

• VIX Convexity (June)
• Crises, Event Theta and Risk Assessment (July)
• Volatility During Crises (cover article for August)
• A History of VIX Futures Roll Yields (September)

There was a time that I felt that if I did not offer my thoughts on the VIX, the subject would probably be ignored. Now I am delighted to say that there are a number of others who have taken up the cause to provide regular analysis and commentary on the volatility space. Going forward, this gives me more freedom to touch on a wider variety of issues across the investment landscape, but rest assured, the VIX and volatility will always be at the core of my thinking.

Related posts:

• Expiring Monthly May 2011 Issue Recap
• Expiring Monthly April 2011 Issue Recap
• Expiring Monthly March 2011 Issue Recap
• Expiring Monthly January 2011 Issue Recap
• Expiring Monthly December 2011 Issue Recap
• Expiring Monthly November 2010 Issue Recap
• Expiring Monthly October 2010 Issue Recap
• Expiring Monthly September 2010 Issue Recap
• Expiring Monthly August 2010 Issue Recap
• Expiring Monthly July 2010 Issue Recap
• Expiring Monthly June 2010 Issue Recap
• Expiring Monthly May 2010 Issue Recap
• The Education of a Trader (from the May 2010 issue)
• Content Update
• Expiring Monthly: The Option Traders Journal Launches Today
  

Disclosure(s): I am one of the founders and owners of Expiring Monthly