Guest post by Vix and more.
With the VIX at about 14.50 as I type this and a large group of investors convinced that stocks are overbought and/or not properly discounting global macro risk, many are wondering just how to translate their beliefs into an effective trading strategy.
For those who think a long volatility trade is the answer, there is the issue of the significant contango headwinds, where a negative roll yield will pummel net asset values on VIX options and VIX exchange-traded products as a part of the daily rebalancing process, while VIX futures are subjected to a similar decay that reminds me a little bit of a dying helium balloon. Long story short: there is a huge daily penalty being assessed just for holding these long positions.
There are ways to minimize the effect of negative roll yield and typically one of the best of these is to work with positions that focus on the more distant months of the VIX futures term structure. This is generally why VXZ outperforms VXX over an extended period. Unfortunately for aficionados of VXZ, the negative roll yield between the fourth and seventh month VIX futures (VXZ buys the seventh month and sells the front month each day) hit a new record on Monday and continues at near record levels.
So what is a long volatility trader to do?
As we have written over the past sessions. Market is trying to break up, but lacks the conviction, while trading on very light volumes. Santa rally is fading, but has attracted many new longs, that wish not to be long. Volatility has collapsed, and people are once again starting to believe, “this market is so boring and will not move“. These are classical signs of people “giving up”. Too many have been too bearish, all predicting the end of the Eurozone. With the past week’s market action, people are slowly giving up on the bear argument. When liquidity dries up, volatility collapses and bears become bulls, things could suddenly change. Today was such a day, with a rather big reversal.
All we need is the junior quants to start telling us Vol is staying low, because it is now in the short term Garch model.
Some random charts to enjoy, before going to long….
What a week, but the market lost steam today, after the shorts got killed earlier. Market recap rather short today, represented by two charts. Note how the SPX (below) reverses in a classical way. After run up/down, in the market, we get the classical candle telling us the reversal is in. SPX has run up to resistance, 200 day average, a shooting star formation, and of course, Biggs getting bullish again.Time to put those shorts on again. Charts below;
Low volume, no trend action in early European trading. The US markets reversed big time yesterday. At one point we saw a “mini panic” sell off. Broken markets, mainly driven by manipulation, intervention and HFT, are dangerous markets. We believe the sharp rally seen over the past days, with yesterday’s reversal, is the first sign in several weeks, of bulls getting less confident. Possible scenario presented below. SPX short and long term charts presented.
Below daily chart of SPX. Note how the index makes turning points, with tails at “extreme” levels. As we wrote earlier, this is a mean reverting market, and today might just have been that reversal day, so many shorts have been praying for, but now majority have covered. The ones doubling down all the way up, will cover at the first move down, so we could expect fast moves to the downside. Welcome to Greed and Fear Market.