Guest post by Vix and more.
Something strange has happened to the VIX futures in 2012: for the first time in their history, the VIX futures persist in being in violent disagreement with each other. Prior to 2012, for instance, the average difference between the front month and seventh month VIX futures was about 16%. This year that number has surged to more than 38%.
The VIX futures term structure has been in extreme contango (back months higher than front months) for the better part of 2012, with 17 days in which the contango across the full VIX futures curve has exceeded the all-time record that stood prior to 2012. It is almost as if the idea of a flat VIX futures term structure curve is passé and traders are convinced that the short-term volatility picture is perpetually an aberration that bears little resemblance to longer-term volatility expectations. Can these two differing perspectives of the future of volatility meaningfully coexist? If not, which view is likely to be wrong?
Quick update on VIX ETP Products. By Vix and more.
Two thirds of 2012 passed before we saw the first new VIX-based exchange-traded product and it turned out to be an interesting one: the First Trust CBOE S&P 500 Tail Hedge Fund ETF (VIXH), which was introduced at the end of August. VIXH is essentially a portfolio consisting of 99-100% of SPY, augmented by a dynamic allocation of 0-1% of VIX options, with the amount of options determined by the level of the VIX at the beginning of each VIX expiration cycle. This is the first VIX-based ETP to included VIX options among its holdings and it is notable that this product bucks the recent trend and is an ETF instead of an ETN. There are other features of VIXH worth discussing and I will discuss these in future posts.
Good recap by Peter Tchir.
Too Early To Dream of a Fix, but Worth Reviewing what has happened
If “buy and hold” and the “carry trade” is the dumb money, it has done pretty well, even in Spain of all places. There have been opportunities to short Spain and make a lot of money, but it is worth pointing out how resilient it has been.
The best total returns for buying the Spanish 5 year were just over 13%, back in November of last year and this July. Had you bought at the peak of LTRO fever you are still down about 1%. I don’t do buy and hold, and was extremely bearish leading into LTRO, but it is a stark reminder that being short pits you against uneconomic buyers with deep pockets. I am now neutral at these levels, and will go into detail when I examine the risks of “Outright Monetary Transactions” or OMT.
Guest post by Peter Tchir.
I remain confused at these levels. I continue to look at the various markets and come away without a strong opinion. Over the course of the year I have had strong opinions. They have worked out, though I got short too early and long too early, the trades worked well. So not having a strong opinion is unusual.The two exceptions are when I look at CDS and when I look at Apple, but my conclusions there come out completely contradictory.
IG18 at 85. I’ve written about this many times and have been right. I even managed to call the bounce off of 98 back to 102 (it went to 103.5) and back tighter. I find the reasons for that call to continue to play out, and as we approach the September roll and the often disappointing September new issue calendar there are more reasons for this tightening to continue. The problem is that it will not tighten if Apple weakens significantly.
Apple is a Macro Asset Class. We seem to be in one of those periods where Apple has transcended just being a single company, and is an asset class of its own. This isn’t just because it is such a big portion of U.S. indices, though that is a part of the story. What I’m seeing is bears buying into Apple to cover some of their shorts. They are getting hurt on shorts in virtually every area. They hate the market and the economy, but the pain on shorts is too much so they have to cover. Many can’t bring themselves to buy anything since the stench of slow growth, failing Europe, fiscal cliff, etc., is so overpowering, except in the case of Apple. They can bring themselves to buy Apple. It is loved, has done well, investors don’t look at you like you have 4 eyes if you say you own Apple.
Guest post by Peter Tchir.
I remain short. I am flat Spain, Italy, and banks. I am short U.S. stocks here. I like CDS, but think IG18 will drift back to over 100 before it can take another leg tighter.
I think so much has been priced in from the ECB, that we face some disappointment as more plans get leaked or opposition becomes more vocal. I believe the ECB will do something that is sufficient to change the dynamics in Europe for a period of time, but think they are constrained enough, that the market may underestimate their plan. The market will view it as insufficient. LTRO1 remains a prime example. Everyone bought the rumor, sold the news, and then decided they better actually buy the news.
What concerns me most about being short, is that it seems very crowded. Not only is it crowded, but many bears (or underweight bulls) are pointing to the same things as reasons to be short, and some of those reasons don’t seem right to me. Here are 4 things too many people seem to be focused on and drawing potentially the wrong conclusions from, and why I don’t think any pullback at this stage will be meaningful and why I will be looking to cover and get long again on a relatively minor move.
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?
Guest post by Vix and more.
Many novice and advanced VIX followers are scratching their heads today, wondering why the VIX is down more than 5%, hovering around the 14.00 level, when the SPX is down 0.4% and all the major market averages are deeply in the red. More serious students of the VIX will also note that this drop in the VIX comes on a Monday, when the typical VIX “calendar reversion” is generally responsible for about a 1% pop in the volatility index.
The answer to most of these questions lies in yet another idiosyncrasy of the VIX: the roll. Quoting directly from the source, the CBOE Volatility Index (VIX) White Paper, we find these two important nuggets from pages 4 and 9, which I have presented here sequentially for easier consumption:
“The components of VIX are near- and next-term put and call options, usually in the first and second SPX contract months. ‘Near-term options must have at least one week to expiration; a requirement intended to minimize pricing anomalies that might occur close to expiration. When the near-term options have less than a week to expiration, VIX ‘rolls’ to the second and third SPX contract months. For example, on the second Friday in June, VIX would be calculated using SPX options expiring in June and July. On the following Monday, July would replace June as the ‘near-term’ and August would replace July as the ‘next-term.’”
“At the time of the VIX ‘roll,’ both the near-term and next-term options have more than 30 days to expiration. The same formula is used to calculate the 30-day weighted average, but the result is an extrapolation of σ2 1 and σ2 2; i.e., the sum of the weights is still 1, but the near-term weight is greater than 1 and the next-term weight is negative (e.g., 1.25 and – 0.25).” [Emphasis added]
Guest post by Peter Tchir.
There is a lot of talk about low volumes and what that means. There’s also a lot of chatter about low vix and what that means. I don’t pay much attention to each. I watch them, largely because others do, but don’t rely on them too much.
VIX is NOT a “Fear Gauge” and has NO Predictive Value
I have looked and find no useful predictive value from VIX. It may have had some value at one point in time, when only a few weird little quants in the corner took the time to figure it out and traded on it. But that was a long time ago, and its value as a leading indicator has dropped along with the ability to smack it down by hitting VIX futures, or lifting it higher by buying TVIX and other VIX related ETF’s.
It was only a year ago when the world was imploding and the VIX traded at 40+. A few points on the lazy VIX, by Doug Short.
Let’s review the recent volatility, or absence thereof) in the S&P 500. The first chart below features an overlay of the index and the CBOE Volatility Index (VIX) since 2007. The current levels of this index are well below the 20 level, a traditional traditionally associated with increased market risk. A recent WSJ article summarizes the usual interpretation of this indicator.
There was a point in the history of VIX and More that I gave serious consideration to a regular feature in which I unveiled “Strange and Unusual Charts” that presumably had, apart from their novelty, the ability to shine some new light on at least one corner of the investment universe. That being said, I have always had an affinity for presenting charts that show unusual ratios, non-standard time frames and such and while the likes ofChart Porn and Unusual Chart of the Month: VXO and RVX did get me started down a slippery slope, I never quite fell into the habit of tilting wildly at windmills on the plains of StockCharts.com and their brethren.
One rabbit hole that I was definitely the first down and pursued the most aggressively was the VIX:VXV ratio, which one blogger insisted was sure to ultimately be my investing legacy. In all fairness, for the first year following the launch of VXV (essentially a 93-day version of the VIX), the VIX:VXV ratio performed as if it was going to make all other indicators obsolete. Of course, then the financial crisis of 2008 hit and the ratio began sprouting warts all over. While I talk about the VIX:VXV ratio only rarely in this space nowadays, the general idea of which the VIX:VXV ratio is just one instance of what has become one of the main themes of this blog: the idea that an understanding of the VIX futures term structure is critical to understanding the valuation of and trading opportunities available for all VIX products, including futures, options and exchange-traded products.