VIX and More

Wednesday, January 11, 2012

Three New Risk Control ETFs from Direxion

Today Direxion announced they have launched three ETFs whose intent is to match their exposure to an underlying equity index based upon current levels of market volatility. The new ETFs are as follows:

Direxion S&P 500 RC Volatility Response Shares (VSPY)
Direxion S&P 1500 RC Volatility Response Shares (VSPR)
Direxion S&P Latin America 40 RC Volatility Response Shares (VLAT)

The launch of these ETFs expands Direxion’s stable of what they call “rules-based index ETFs,” which began with two ETFs that are based on insider trading data: INSD and KNOW. The three new ETFs also arrive just five days after S&P announced a new S&P Dynamic Rebalancing Risk Control Index Series, which provides the basis for evaluating volatility and matching equity exposure to anticipated risk.

The intent of these ETFs is spelled out by Direxion:

“The Funds embody a rules-based investment approach that uses volatility as a gauge to determine equity exposure. They operate according to the principle that exposure to equities should be reduced during periods of higher overall market volatility, and increased during periods of a more stable (lower volatility) market environment. Each Fund has a target volatility level for its corresponding index. When volatility moves above those levels, the Funds will increase their exposure to U.S. Treasuries and decrease their exposure to equities. The Funds will proportionately increase exposure to equities during periods of low market volatility.”

Readers with sharp memories may recall that back in July 2010, Direxion was the first ETF provider to announce that they would be launching a product based on the S&P 500 Dynamic VEQTOR Index, which was an effort to mitigate risk with a dynamic allocation of VIX short-term futures, essentially the equivalent of sizing a VXX hedge based on observed levels of implied volatility and historical volatility. I am not sure why Direxion’s VEQTOR product never saw the light of day, but Barclays ended up with one of the few successful VIX ETPs in 2011 (see VIX Exchange-Traded Products: The Year in Review, 2011) with its Barclays ETN+ S&P VEQTOR ETN (VQT) product, which I made a strong case for back in October 2010 in The Case for VQT.

One of the interesting aspects of the approach taken by VSPY, VSPR and VLAT is that these products will tend to have minimum exposure when the VIX is at its highest – and as anyone who has ever looked a chart of the VIX and SPX/SPY knows, this is typically when stocks bottom and begin a sharp bullish move.

With impeccable timing, EconomPic Data just happened to publish a study yesterday, VIX as a Predictor of Equity Returns, which concluded that for the most part, SPY daily returns were much higher with an elevated VIX than with a historically low VIX.

All this raises the question of how to play increased volatility and risk. In the land of ETPs, there are quite a few alternatives, including:

Barclays ETN+ S&P VEQTOR ETN (VQT) – dynamically hedge with a long VIX futures position
Direxion’s VSPY and VSPR to dynamically adjust exposure to equities
PowerShares low volatility (SPLV) and high beta (SPHB) approaches for manual market timing
ETRACS Fisher-Gartman Risk On ETN (ONN) and ETRACS Fisher-Gartman Risk Off ETN (OFF) – for those who wish to manually time the multi-asset class risk on/risk off trade

Investors who believe they are more adept at timing the market may prefer to avoid the rules-based products that dynamically adjust exposure based on a static risk measurement mechanism. For those who prefer not to watch their portfolio closely or are not convinced that they can do a better job than the likes of VQT, VSPY and perhaps SPLV, the new category of dynamic risk exposure products should provide some excellent tools for portfolio augmentation and in some cases, portfolio replacement.

Disclosure(s): short VXX at time of writing

Friday, January 6, 2012

VXV Heralding a Return to Normalcy

With the political season heating up, it seemed like an opportune time to work “normalcy” into one of my posts again and what better way to do that than by putting under the microscope one of my favorite overlooked indices: the CBOE S&P 500 3-Month Volatility Index, which I typically reference with the more pithy VXV ticker symbol.

For those not familiar with VXV, I am fairly sure I was the first person to discuss this index back in 2007, talk about the merits of the VIX:VXV ratio (which is a great way for someone without VIX futures quotes to keep on top of the VIX futures term structure), devote an entire Barron’s column to the subject (Take a Longer View on Volatility) and promote VXV as a better reflection of long-term and structural/systemic volatility than the VIX, which is better suited to measuring short-term event volatility.

For those who desire some additional background and context, there are shiploads of prior posts on the subject and the links below should provide for some excellent jumping off points.

Getting back to VXV, I think it is important to note that while the VIX remains above its December lows, VXV has now moved below those lows and it plumbing levels that have not been seen since early August – and as VXV is a better gauge of structural and systemic risk than the VIX (not to mention largely untouched by the holiday effect), I think this is an important development to watch.

Frankly, the VXV chart looks a lot like it did back in early April 2009, when I penned Chart of the Week: VXV and Systemic Failure. At that time I concluded, “The key takeaway: systemic healing is continuing and the risk of systemic failure is diminishing.” Based on the VXV chart, it appears as if we are at a similar moment in time right now.

[source(s): StockCharts.com]

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

Thursday, January 5, 2012

VIX and More and the 2012 Bespoke Roundtable

I was delighted to be invited back for the third year in a row to share my thoughts about 2011 and 2012 as a part of Bespoke Investment Group’s third annual Roundtable.

As someone who trades options, just predicting what one stock or index will do over the course of a four-week expiration cycle can be a humbling experience. Since I rarely focus the bulk of my thinking more than two or three expiration cycles into the future, I always embrace the process of what I have come to think of as Bespoke’s comprehensive 37 question “take-home final.” Of course you don’t have to have an opinion about every issue out there to be a successful investor, but being informed about as many issues as possible makes you better prepared when the next surprise hits. As I noted in The Education of a Trader, anyone who has ever uttered, “Do we have to know this for the test?” is not cut out for trading, as every day in the financial markets is an open book pop quiz.

When it comes to formulating answers to these 37 questions, I tried to balance what I think are the most likely scenarios with more provocative comments about some low probability scenarios that I believe that a higher likelihood of coming to fruition than the rest of the crowd. The result is typically a patchwork of the unexciting and the outrageous. In 2012 it looks like I am leaning more toward the unexciting end of the scale, which is not difficult to do in a year in which the Mayan calendar may be predicting the end of the world, while many pundits are calling for at a minimum the end of the euro zone as we know it. That being said, I do think I have some provocative things to say about a wide range of issues, from Apple (AAPL) vs. Google (GOOG) to social networking and beyond.

The full set of my comments for 2012 is here.

For those who are curious how my crystal ball has fared in years past, my archived predictions for 2010 are here. If I can locate a link to my (decidedly less impressive) 2011 predictions, I will post that here as well.

I also recommend reading through some of the comments from the other participants in the 2012 Bespoke Roundtable. A splash page for the full set of predictions is here.

Disclosure(s): none

Tuesday, January 3, 2012

Covered Calls Finish Strong in 2011

Just looking back at The Year in VIX and Volatility (2011) is enough to make one’s stomach churn. Try to tell someone who has acrophobia that even the scariest roller coaster ride ends up right where it started and you will likely not assuage any fears. Something similar is at work for hikers, bikers or mountain climbers. The amount of effort they will need to call upon has nothing to do with ending up at the same elevation they started, but rather it is the cumulative elevation gain over the course of the trail, road or mountain. As with many things in life, it is all about the journey, not the destination.

For those who may have a touch of acrophobia, prefer their hikes to put less stress on their cardiovascular system and want a portfolio that matches the way they wish to experience the world, covered calls or buy-write strategies might be the answer. I have addressed the subject of covered calls and buy-writes a number of times in the past in this space (see links below), but essentially this is a strategy which sells calls against an existing (covered call) or new (buy-write) long position in order to generate income off of the underlying. Covered calls and buy-writes will generally beat the SPX/SPY if stocks decline, move sideways or rise slowly. The cost to implementing one of these strategies is that if the markets make a sharp bullish move, gains are capped by the covered calls.

In the ETP world, there are two choices when it comes to buy-write strategies:

PowerShares S&P 500 BuyWrite Portfolio ETF (PBP)
iPath CBOE S&P 500 BuyWrite Index ETN (BWV)

PBP is by far the more liquid of the two alternatives, but some investors may have a reason to prefer BWV’s approach and performance.

In the chart below, I have captured the equity curve of PBP vs. SPY over the course of the second half of 2011 – a period in which stocks generally moved sideways and volatility remained high. In other words, a period that was tailor-made for buy-write strategies. Note that PBP outperformed SPY by 7.7% during this six-month period, with considerably less volatility and also a less peak-to-trough drawdown…or what alpinists would probably call cumulative elevation loss.

Should high volatility persist in 2012 and stocks end up near where they started the year, both PBP and BWV are likely to outperform the major market indices once again.

[source(s): ETFreplay.com]

Disclosure(s): long PBP at time of writing; TradeKing is an advertiser on VIX and More

Monday, January 2, 2012

The Year in VIX and Volatility (2011)

One of the most-loved charts I assemble each year is my retrospective look at the year in volatility. I already touched on some of the highlights of event volatility in text form in Expectations, Surprises and Fear in 2011, but this is one case in which I believe a picture does a better job of telling the story in the context of a timeline for the entire year.

From a volatility perspective, the first half of 2011 was relatively benign, even though the global social and economic fabric was ripped by Arab Spring and the Japanese trio of disasters which came in the form of the earthquake, tsunami and nuclear meltdown.

Things were much more promising during the middle of the year when the Greek parliament voted in favor of austerity and the euro zone agreed to expand the European Financial Stability Facility (EFSF) to €780 million.

For a while, there was considerable angst surrounding the bipartisan politics associated with the U.S. debt ceiling deadline at the beginning of August, but only after the Democrats and Republicans failed to come up with a meaningful debt reduction deal did investor anxiety shift back to Europe. Ironically, the downgrade of the U.S. debt from AAA to AA+ had very little impact on Treasury securities, which actually began to rally sharply after the downgrade. When Europe returned to the center stage, however, the sovereign debt crisis was escalating rapidly and it was now Italy that was in the crosshairs. The VIX shot up to 48 on August 8^th and was regularly above 30 through the end of November, setting a new record for persistent backwardation in the VIX futures in the process.

The VIX was a high wire act throughout August and September, with multiple excursions into the 40s. Even after the S&P 500 index bottomed on October 4 at 1074, the VIX remained stubbornly elevated in October and November, before finally falling into the 20s in December. While the SPX was essentially unchanged for the year, the VIX ended 2011 at 23.40, up 31.8% over 2010’s close of 17.75. At the same time, the VIX futures are calling for a VIX of between 29 and 30 by the mid-point of 2012, suggesting that volatility will climb higher once again in the coming months.

In a year where most asset classes struggled mightily, volatility was one of the few great long positions. With a higher starting point going into 2012, it will be difficult for the VIX to repeat its market-beating performance once again, but if the euro zone and some of the geopolitical flash points fail to make progress, 2012 may indeed be the year of the VIX.

Finally, since I had so many requests for a high-resolution version to download last year, I am going to preemptively offer a full resolution PNG screen capture of the graphic below for download here.

[source(s): StockCharts.com]

Disclosure(s): none

Friday, December 30, 2011

CBOE To Launch Futures on Emerging Markets Volatility (VXEEM)

One of the predictions I made for 2011 was that the trend toward what I have labeled “atomic volatility” (a lessening of the scope of the underlying for options contracts and/or the duration of those contracts) would accelerate.

Back in March 2011, the CBOE helped to usher in the atomic volatility era when they rolled out volatility indices using the VIX methodology for six sector and geography ETFs:

iShares MSCI Emerging Markets Index Fund (VXEEM)
iShares Trust FTSE China 25 Index Fund (VXFXI)
iShares MSCI Brazil Index Fund (VXEWZ)
Market Vectors Gold Miners Fund (VXGDX)
iShares Silver Trust (VXSLV)
Energy Select Sector SPDR (VXXLE)

Later in March, the CBOE rolled out futures based on the gold volatility index (GVZ), which was launched back in August 2008, at the same time as the euro volatility index (EVZ) and several weeks after the launch of the OVX, known affectionately as “the Oil VIX.” [Those who are interested in the sequencing of the launch of various volatility measures should refer to The Evolution of the Volatility Index Family Tree.]

Now the CBOE is taking the next step with VXEEM, the volatility index that is based on the popular emerging markets ETF (EEM), and offering futures on that index. The launch of these futures contracts is set for January 9^th and will initially include contracts with expirations in February, March, April and May. Note that the expiration cycles for these contracts are the same as those for the VIX futures and options, meaning that they will expire on Wednesdays (February 15, March 21, April 18 and May 16) and can last be traded on the Tuesday immediately following the expiration. For more information, check out the CBOE’s VXEEM splash page and information circular.

One of the reasons I think products based on EEM and VXEEM have a good chance of being successful is that emerging markets are typically a highly volatile area – much more so than the basket of stocks included in the S&P 500 index on which the VIX is based. Right now, for instance, EEM has a 60-day historical volatility that is more than 50% higher than that of the SPX. All this means that short-term traders should find VXEEM products (futures as well as options and ETPs, assuming they are in the pipeline) to be the types of high-octane trading vehicles that are well-suited to some of their favorite strategies, much like leveraged ETPs and VIX-based products.

Additionally, as the chart below reminds us, emerging markets sometimes move in cycles that are distinct from U.S. stocks. Note that the ratio of EEM to SPX has varied wildly over the course of the past five years and has had different bottoms and tops than the SPX has. Whether this phenomenon will continue into the future (influenced strongly by China) remains to be seen, but the role of emerging markets relative to developed markets should be watched closely in 2012.

[source(s): StockCharts.com]

Disclosure(s): none

Thursday, December 29, 2011

Expectations, Surprises and Fear in 2011

For the last three years, the holiday season has been leaving me something new in my stocking: a detailed questionnaire from Bespoke Investment Group that provides the raw material for the annual roundtable…and undoubtedly more than a couple of snickers for Justin, Paul and the gang.

In the inaugural year of the Bespoke roundtable, my crystal ball guesstimates for 2010 proved to be surprisingly accurate, naturally leading me to debate the relative influence of luck vs. skill when I had a chance to reflect back on the events of the year.

When I made my predictions for 2011, I had serious concerns about Europe and China in particular, but before January was over, the dawning of the Arab Spring had begun to change the world in a profound and dramatic way, cutting across religious, political and economic dimensions. While the VIX remained in the teens for almost all of January and February, I suspect that when we reflect back on the events of 2011 in another decade or so, the widespread tumult in Northern Africa and the Middle East is likely to produce a more profound long-term effect on the world than any of the other events of the year.

As the Arab Spring continued its geographic spread, a trio of disasters shook Japan, starting with the magnitude 9.0 Tohoku earthquake and tsunami, which was followed by a nuclear meltdown at the Fukushima Daiichi nuclear power plant.

So while Europe and China were simmering on the back burner, two huge and unforeseen events reverberated around the world, both of which triggered a large number of downstream consequences.

Events in Europe began heating up in the middle of the year, but they were largely overshadowed by the growing angst over the U.S. debt ceiling crisis and the political gridlock that seemed poised to prevent a solution to that crisis. Only after a partial ‘solution’ to the debt ceiling issue was agreed upon and S&P downgraded the credit rating of the U.S. from AAA to AA+ did the European sovereign debt crisis return to the center stage, this time roiling the markets throughout the remainder of the year.

In retrospect, being able to anticipate some of the surprises of 2011 would have required expert knowledge of such far-reaching fields as Arab social unrest, plate tectonics, and the inner workings of governments in the U.S., Greece and elsewhere. On top of all this, it is never easy to discern when a seemingly harmless development will suddenly mushroom out of control into a crisis. Knowledge of this type is much more elusive and requires an understanding of concepts like “fingers of instability” which is discussed by Mark Buchanan at length in Ubiquity: Why Catastrophes Happen – and which is a topic I shall pursue in more detail in 2012.

The bottom line is that many of the big risks for 2012 are obvious: Europe, China, Iran, North Korea, etc.

What keeps option sellers up at night and often puts oversized dents in portfolios are those unknown unknowns lurking just below the surface.

[source(s): StockCharts.com]

Disclosure(s): none

Wednesday, December 28, 2011

Italy’s Sovereign Debt Schedule and the VIX

When I think about the risks posed by the European sovereign debt crisis in 2012, the first thing that comes to mind is the huge amount of debt that Italy has to roll over next year. In yesterday’s staff meeting/run with Logan (What My Dog Can Tell Us About Volatility) I even floated the semi-sexy label of “peak refinancing.” He was not particularly impressed…

But I’m sure that somewhere under that calm demeanor, Logan too is worried about Italy and how well that pivotal country will manage the burden of refinancing. Of particular concern is that the refinancing schedule has a three month stretch from February through April in which the debt that is coming due is particularly large – €91.7 billion, just under half of the total redemptions for the entire year.

The table below summarizes the monthly estimates of Italy’s 2012 issuance (per HSBC), as well as the schedule of redemptions and net issuance minus redemptions for each month.

In planning for the timing of elevated anxiety and perhaps a full-blown crisis in Europe in 2012, one would think that Italy’s debt schedule would figure prominently into those calculations. I would also expect to see some of that timetable translated into elevated VIX futures, which I have included at the bottom of the table below. In fact, the 2012 VIX futures term structure is very similar to what it looked like prior to the August selloff, with no hint at all that volatility might peak in February, March or April.

When it comes to pricing options for 2012, keep Italy’s debt schedule in mind, regardless of whether the VIX futures are paying attention to this issue.

[source(s): Italy Department of Treasury, HSBC, Interactive Brokers]

Disclosure(s): none

Tuesday, December 27, 2011

Q & A: The Historical Volatility of VQT

Questions from readers are where I get to learn which aspects of volatility cause the most confusion and consternation among investors, so one of the things I will strive to do in 2012 is take more of the Q&A exchanges that might be buried in the comments sections of previous posts and shine some light on them here.

I was reminded of the importance of Q&A when I stumbled upon the following comment to VIX Exchange-Traded Products: The Year in Review, 2011, which I fear may have been lost in the holiday shuffle. [For the record, I tagged that post with my elusive “hall of fame” label, which I typically use to honor only handful of posts each year.]

The comment/question was posted as follows:

Thank you for alerting me to VQT. Where does one find the realized volatility number on it...or is this number just the VIX?

Before I dive into the issue of the realized or historical volatility (the two terms are synonymous) of VQT, I would be remiss in not pointing out that the question suggests some confusion between realized volatility and the VIX.

First things first, realized volatility is also known as historical volatility because it is based on past price moves, has already been observed, and can be calculated with great precision (see Calculating Centered and Non-Centered Historical Volatility for more details.) This is essentially what an investor sees out his or her rear view mirror.

Implied volatility is a very different animal from its realized/historical cousin. It boils down to the market’s best guess as to what (historical) volatility will look like in the future, based on how much investors are currently paying for options. The VIX is a specific instance of implied volatility and is based on options on the S&P 500 index over the course of the next 30 days. To return to the car analogy, it is what the consensus of drivers believe will be around the next bend and over the horizon.

Getting back to VQT, the chart below captures historical volatility based on past daily price moves in VQT for lookback periods of 10 days, 20 days, 30 days, 50 days and 100 days. As these are calculated based on price moves, they are necessarily based on trading days, not calendar days, which are the unit of time used for implied volatility data.

Looking at the table, these historical volatility numbers for VQT are in 10.50 - 10.90 range for the past 30 trading days. The 100-day lookback window takes us back to early August, so it is not surprising that 100-day historical volatility is higher at 14.30.

I have also included some historical volatility data for the S&P 500 index (SPX) for comparison purposes. Note that historical volatility for the SPX has been 100 – 130% higher than it has been for VQT during the same lookback periods.

One can find historical volatility data on sites from brokers that specialize in options (optionsXpress, TradeMonster, Trade King, thinkorswim/TD Ameritrade, etc.) or from options data providers such as Livevol and iVolatility.

Disclosure(s):
optionsXpress, TradeMonster, Trade King and Livevol are advertisers on VIX and More

Friday, December 23, 2011

VIX Exchange-Traded Products: The Year in Review, 2011

The year is not quite over, but I can safely predict that it when it is in the books, there will be no doubt that 2011 has been a bull market for VIX exchange-traded products (ETPs). After seeing two VIX ETPs launched in 2009 and ten in 2010, this year has witnessed the launch of 20 VIX ETPs.

In the week ahead I will provide some commentary about the evolution of VIX ETPs in 2011 and what to look for in 2012, but for now I wanted to share a performance table for a cross-section of VIX ETPs that were open for the full year.

Before I touch upon on the graphic below, I wanted first to comment on the time periods used for the performance data. Now perhaps my life is too complicated, as it seems I have to simultaneously sync it to three different calendars: the standard Gregorian calendar, the options expiration calendar (particularly the standard Friday monthly and weekly expirations) and the VIX options expiration calendar (featuring VIX options and futures expiration on those Wednesdays highlighted by purple squares in the preceding link.) The graphic below uses the VIX options expiration cycle, specifically measuring from Tuesday’s close immediately before VIX options expiration to the next Tuesday’s close just prior to VIX options expiration the following month. This means that the January 2011 entry includes the full VIX options expiration cycle for that month: December 22, 2010 – January 18, 201. This also means the most recent December 2011 data covers the full December VIX options expiration cycle: November 16, 2011 – December 20, 2011.

In the graphic below, I have highlighted the best performing (VIX expiration cycle) month for the SPX in green and the worst performing month in red. Note that over the course of the full year (December 22, 2010 – December 20, 2011) each of the VIX ETPs (long volatility in green and short volatility in red) managed to lose value, even though the VIX was up over 40% during that period. The one exception is VQT, which consists largely of a SPY position, with a dynamic allocation of VXX that ranges from 2.5% to 40% of the ETPs holdings. [For more information on VQT, refer to The Case for VQT and Barclays VEQTOR ETN (VQT) Begins Trading.]

While it is interesting that both the long and short volatility ETPs were unable to turn a profit for the year, there were stretches during 2011 that various VIX ETPs produced extraordinary gains.

As promised, I will delve more into the performance of the universe of VIX ETPs and their suitability as speculative and hedging plays before the end of the year and in the weeks and months ahead.

Disclosure(s): long XIV, ZIV and VQT; short TVIX and VXX at time of writing

Friday, December 16, 2011

VIX and St. Louis Fed’s Financial Stress Index Moving in Concert

Last year I talked about the St. Louis Fed’s Financial Stress Index (which I am calling the STLFSI in order to lower my carpal tunnel risk) as a measure of financial market risk that I consider complementary to the VIX and in some cases perhaps even a superior alternative.

Given the fact that some investors have difficulty coming to terms with the “holiday effect” and the seasonal swoon in the VIX, I thought it might be timely to update a chart I have posted here previously which captures the movements in the more broad-based STLSFI. Note that the chart dates from January 2007 and includes all the data from the financial meltdown of 2008, as well as the various permutations of the European sovereign debt crisis that have plagued the financial markets during the last two years or so. [Data are through the last update to the STLFSI, 12/9/11.]

Looking at some of the spikes in the chart, the first thing that strikes me is just how closely the two measures of risk have moved during the past five years. Also worth noting is the fact that both the VIX and the STLFSI indicate that the degree of risk/stress in the financial markets over the last few months has been slightly higher than what happened in one of the earlier Greek chapters of the euro zone debacle back in May and June of 2010.

More importantly perhaps, both the recent VIX and STLFSI data suggest that the current threats to the global financial markets are at least an order of magnitude lower than what we experienced in late 2008 and early 2009. This is not to say that both the VIX and STLFSI cannot spike much higher in short order, only that according to both measures, we now appear to be on the downhill side of the crisis.

For more information on the components of the STLFSI and the index’s long-term performance, check out St. Louis Fed’s Financial Stress Index.

[source: Federal Reserve Bank of St. Louis]

Disclosure(s): none

Thursday, December 15, 2011

The Year in Safe Havens

Earlier today, in Safe Haven Options Shrinking? I noted the recent failure of some of the safe haven trades in volatility, gold and crude oil securities to hedge the latest decline in stocks.

A question many observers have is how well these “big five” safe haven trades – volatility (VXX), gold (GLD), crude oil (BNO), the dollar (UUP) and U.S. Treasuries (TLT) – have fared over the full extent of the 2011 volatility storms, from the Arab Spring and Japanese earthquake/tsunami/nuclear disaster duo during the first quarter, to the U.S. debt ceiling debacle and the seemingly endless wave of disasters associated with the European sovereign debt crisis that plagued investors for the balance of 2011.

The graphic below, courtesy of ETFreplay.com, shows the year-to-date performance of big five safe haven ETPs, as well as historical volatility and drawdown data.

It is worth noting that while VXX is up for the year, it may be difficult to think of anything as a safe haven that was down 46.6% peak-to-trough earlier in the year.

Looking back with 20-20 hindsight, if one could have switched between safe haven vehicles at the most opportune time of the year, Brent crude would have been the best bet throughout the Arab Spring and up until early June, at which point gold would have been the horse to ride until August, with volatility the best play through the beginning of October and Treasuries the ideal hedge for the last two months. While the dollar has turned up as of late, the relatively low volatility in the currency market (assuming no use of leverage) means that the dollar is a better place to park investing capital until the perceived threat passes than to be employed as a hedge against a downward move in stocks.

[source: ETFreplay.com]

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

Safe Haven Options Shrinking?

Back in February, in Chart of the Week: Flight-to-Safety ETPs, I examined the year-to-date performance of five exchange-traded products (ETPs) that are central to the flight-to-safety trade: volatility (VXX), gold (GLD), crude oil (USO), the dollar (UUP) and U.S. Treasuries (TLT). At that time, the Arab Spring was considered to be the main risk to portfolios and I noted that with the exception of crude oil, none of these supposedly safe havens had been profitable for the first two months of the year.

Ten months later the risk landscape is a much different one and TLT (+33.7), GLD (+10.2%) and VXX (+8.4%) have all lodged fairly impressive gains. While the dollar is flat, the picture in crude oil depends on where you look, with USO down 6.0% and BNO (a much better measure of global crude oil prices) up 15.7%.

So while it seems as if the safe havens have had a good year, a large part of that picture has changed during the first two weeks of December. Most notably, implied volatility, gold and crude oil have declined sharply in concert with stock prices, with all three acting as ‘negative hedges’ and adding insult to injury for those who were looking to cushion losses instead of exacerbate them.

Of the big five flight-to-safety vehicles, this leaves just U.S. Treasuries and the dollar as having been successful during the first half of December. With rates on the U.S. Treasuries at all-time lows and seemingly everyone waiting to time the Bill Gross short trade better than the bond master himself, this leaves only a currency that is less debased than most of its competition.

So where is the safe haven? Not too many years ago, many thought real estate was the best safe haven.

Right now one interesting short-term play is EUO, the ProShares UltraShort euro ETF, where the ETFs objective is to move -2x the daily direction of the euro.

[source: StockCharts.com]

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

Wednesday, December 14, 2011

High and Low Volatility ETPs

Since Barclays/iShares launched the first VIX-based exchange-traded products (ETPs) three years ago next month, the landscape of volatility ETPs has been dominated by products that are based on VIX futures. This should come as no surprise to investors, since the cash VIX (or VIX index quoted on CNBC and elsewhere) cannot be traded directly.

In early May, however, PowerShares elected to go in a different direction and launched the PowerShares S&P 500 Low Volatility Portfolio (SPLV) on one end of the spectrum and the PowerShares S&P 500 High Beta Portfolio (SPHB) at the more volatile end of the spectrum. [I’m guessing that a “High Volatility” moniker didn’t make it very far with either the legal or marketing folks…]

Three weeks after the PowerShares products, Russell Investments peppered the market with a launch of ten different “factor ETFs” which also address investor demand for products with high and low volatility, beta, momentum, etc. over the Russell 2000 and Russell 1000 universe, later followed by three international variants. Since then, several other issuers have entered the market with similar products.

By far the products that have received the most attention from investors have been the low volatility ETPs, with SPLV leading the pack with a market share of around 80%.

So far these volatility/beta ETPs have attracted approximately $800 million in assets, about 1/3 of the amount that is invested in VIX-based ETPs.

While the low volatility products have performed quite well since their launch and I understand the visceral desire to hold low volatility products in a high volatility world, as I see it, holding low beta stocks (SPLV top holdings) is just another way at market timing and not necessarily better over the long haul than diversifying with bonds or even more cash.

Going forward, I will spend some time analyzing the performance of SPLV, SPHB and some other ETPs in the volatility/beta group. In the meantime, give some thought to the possibility that even though utilities (XLU) have been superb performers in 2011, these are not necessarily the best long-term investments for most of us.

Disclosure(s): none

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