A New Volatility Regime of Generally Higher Values than a Year Ago
With the Chinese stock market on holiday (the Shanghai and Hong Kong markets were closed Thursday and Friday in remembrance of the 70th anniversary of World War II), volatility has stabilized. However, amid persisting uncertainty about the world economy, it is a new regime. Values are significantly higher than a year ago, especially for equities.
Figure 1. Weekly Update on Volatility Levels
VIX Futures in Backwardation More
The Weekly News Roundup is your weekly recap of CBOE features, options industry news and VIX and volatility-related articles from print, broadcast and online and social media outlets.
Long Live Volatility
Traders are hopping on the VIX roller coaster, taking advantage of the recent volatility in the market. But is volatility here to stay?
“VIX to Investors: Fade the Decline,” Steve Sears, Barron’s
“Options Premium Sellers Make Hay While Volatility Rules,” Saqib Iqbal Ahmed, Reuters
“Will This Volatility Pop Outlast the Financial Crisis?,” Adam Warner, Schaeffer’s Investment Research
“Expect more volatility. But don’t let it freak you out,” Gigi Douban, Marketplace
“Making Sense of Market Volatility: It’s All About the VIX,” Randy Warren, Forbes
“Odd Price Disparity in VIX Hedges Due to Expected Volatility,” Mark Melin, Value Walk
August Volume Highs
Trading records set during August at CBOE Holdings included single-day volume highs for CBOE, C2, total index options and SPX options, and monthly ADV highs for VIX options and SPX options. At CFE, August was the second busiest month of all time.
“CBOE Reports August 2015 Volumes, Options Business Outperforms,” Jeff Patterson, Finance Magnates
“CBOE Futures Exchange Reports Jump in August 2015 Trading Volume,” Hedgeweek
After a hiatus of almost a year (the October 2014 pullback, to be exact), I have reprised the VIX and More Fear Poll in an attempt to get some insight into which issues have been responsible for bring fear back into the investing equation and in so triggering the highest VIX spike (53.29) outside of the 2008-09 financial crisis and the #5 and #6 one-day VIX spikes ever on consecutive days.
In the chart below, I have summarized the top ten responses from almost 400 voters, covering 40 countries over the past two days. The question: “Which of the following makes you most fearful anxious or uncertain about the stock market?”
[source(s): VIX and More]
I should note that Tuesday’s responses had “Market structural integrity (high-frequency trading, flash crashes, exchange stability, etc.)” as the #1 concern, but a late flurry of votes today for “China – weak economic growth” put China concerns over the top. Combining Chinese growth concerns with concerns about a bubble in Chinese stocks and/or housing makes it a landslide in favor of all things China. Without too much of a stretch, one could also lump in the likes of currency problems, deflation, low crude oil prices and falling commodities prices in general into a broader China-related bucket and suddenly the China + ripple effect accounts for about 50% of the votes.
As always, I love to see how the American view of the world contrasts with those non-U.S. respondents. This time around, the area most overemphasized by Americans relative to the rest of the world is, in classic Americentric myopia fashion…”U.S. – weak economic growth,” which 8.7% more Americans label as their #1 concern than their non-U.S. counterparts. Conversely, the biggest blind spot for Americans – at least relative to the concerns of the rest of the world – is commodities prices, which Americans underweight by 5.1%. A close second in the American myopia sweepstakes is Chinese bubbles in stocks and/or housing. I do not find the commodities oversight to be surprising, but certainly the relatively low concern about Chinese bubbles is unexpected.
For those who have not seen some of the earlier incarnations of this poll, these date back to 2012 and chronicle a U.S. public that was so obsessed with the fiscal cliff that they did not fully appreciate the gravity of the European sovereign debt crisis.
Some of the intermediate-term indicators seem ready to capitulate and issue buys, but the overall picture is far from “all clear” at this point. Despite recurring volatility, $SPX has traded in a new range in the last couple of weeks — 1870 to 1990.
There has been a lot of talk in the media about a “retest” of the lows, where amateur technicians are saying that the market “almost always” retests the lows of a sharp selloff. In fact, with so many people looking for a retest, I would say that one of two things is more likely: a) the market won’t retest the 1870 level at all, or b) it will blow right on through 1870, heading for the October lows at 1820 as the next support level.
To summarize the $SPX chart: it is bearish in that it is now trending lower, and that will continue to be true unless and until the resistance at 1990 is overcome.
Put-call ratios have continued to rise daily, no matter what $SPX has done. Both equity-only put-call ratios (Figures 2 and 3) are now above where they were last October. As a result, they are in oversold territory. Moreover, the computer programs that we use to analyze these charts have called for buy signals on both of them as of the close of trading today, September 3rd.
Market breadth has improved in the last week. As a result, both breadth oscillators have rolled over to buy signals.
The trend of $VIX is still rising at this point, though, and that is intermediate-term bearish. In my opinion, $VIX would have to close below 19 in order to break the uptrend that is place.
In summary, short-term oversold conditions continue to build up but for the major outlook to become more positive, it will be necessary for the intermediate-term indicators to change from their current bearish positions. Until then, the intermediate-term outlook remains bearish.
The price of crude oil has not seen such a precipitous drop in price since 2008 when the overall economy cratered. On July 11th, 2008 crude closed at $144.96. On December 19th, 2008 crude closed at $33.17. Today the economy is not imploding. The drop in price is attributed more to an excess of supply instead of a weakened demand. The spot price of crude is currently trading below $42, less than half of its $96 price twelve months ago. Some analysts are calling for a price below $30 a barrel.
It’s next to impossible to pick tops and bottoms in the market. What if oil is at or near the bottom? Let’s look at an individual equity that closely tracks the price of crude oil. Chevron (CVX) closed at 80.91 on August 19th. On July 24th, 2014 CVX was trading at 134.85. As recently as April 28th, 2015 CVX was trading at 111.73. That’s a 27% drop in less than four months.
You can buy 100 shares of CVX @ 80.91 for $8,091. If you margin your purchase you only have to lay out $4,045.50. Of course should CVX continue to drop, you will need to throw more money into your purchase of CVX. Your maximum possible loss either way is $8,091. Another alternative would be to buy ten CVX January 95 calls @ 0.76. The current bid/ask spread in those options is 0.66-0.76. That would cost you $760. Your upside breakeven point on the trade would be 95.76. Expiration on those options is 150 days away. If the price shot up to 95.76 immediately it would not be a breakeven trade. As you can see on the graph it would be an immensely profitable trade. As time goes by it becomes less and less profitable due to the decline in time value that is embedded in the premium. More
Next week is a holiday shortened week and sort of between earnings seasons as well, but we do have three companies with Weeklys available reporting. Probably the most exciting name is LULU. Also note this history PANW is less than the standard 12 quarters as the company has only been around long enough to report 11 times.
Before getting to the trade, indulge me for a second while I show the value of selling puts in a broad based market index…
The CBOE S&P 500 PutWrite Index (PUT) is an excellent depiction of the benefits of selling puts. The chart below shows the performance of PUT versus the total return for the S&P 500 from January 1990 through the end of August 2015. Both returns are displayed assuming $100 was invested at the beginning of 1990. Note over time PUT outperforms the total return of the S&P 500 by about $150.
At this point some readers are thinking, “that’s great, but I’m not allowed to sell uncovered puts in my account”. Well there was a block trade I came across from Monday that appears to address this very issue.
The last big trade of the day this past Monday involved a trade that sold the RUT Sep 18th 1070 Puts at 5.37 and purchased the RUT Sep 18th 700 Puts for 0.10. That trade occurred when the Russell 2000 was quoted at 1159.42. Therefore as long as the Russell 2000 does not lose about 7.7% between the trade date and the middle of September this trade results in a winner equal to the 5.27 credit received when the trade was initiated.
If the equity market has a historic melt down and the Russell 2000 is at 700 or lower on September 18th settlement then this trade will incur a loss of about 454 points. Typically the purchase of a put in a bull put spread is done in order to limit losses. In this case the Russell 2000 needs to drop about 40% in two weeks for the 700 strike puts to begin to add value. When I see one of these trades where a deep out of the money put is purchased, my assumption is the motivation is more about being short a put, but not being allowed to have a ‘naked’ short put position due to a trader’s permission levels. It is a work around that allows trader to achieve a similar risk / reward that is associated with naked short put positions in cases where they may not be allowed to initiate uncovered short option positions..
For more on the CBOE Put Write Index visit www.cboe.com/put
For more on Russell 2000 Index Options visit www.cboe.com/rut
When markets opened on Monday, August 24, a slew of sell orders were already lined up, causing many computer systems to go haywire. Many brokers were locked out, and with market makers and specialists unwilling to take action, we saw enormous bid/ask spreads, stops being hit at very low levels, and frozen markets. This all occurred at the opening bell, and it was quickly fixed when some traders saw opportunity and dove right in on the buy side.
This was flash crash 2015, and it happened so quickly that nobody seemed to be concerned. In fact, no one expressed shock that it happened, which I find really surprising.
For the past five years, I’ve heard discussion about “bears” who vowed to get a piece of the next flash crash, which was inevitable. During the May 2010 flash crash, Apple shares dropped $100 in one day only to rebound sharply, and anyone who missed it vowed they wouldn’t miss another. When the flash crash happened last Monday, those waiting for it probably missed this one, too, simply because they were more shocked by (and paying attention to) the dramatic decline leading up to the open.
This flash crash was very different from the one that occurred in 2010. During the 2010 flash crash, the Dow plunged nearly 1,000 points and lasted for an hour (but it seemed like a lifetime). The flash crash on Monday passed very quickly – it lasted about 30 minutes. During that time, bid/ask spreads were wider than an 18 wheeler; one quote I saw for Skyworks Solutions (SWKS) had a bid/ask spread of 70 x 82 (the stock closed the prior day at 82).
A person who takes an opposing view. One who rejects the majority opinion as in economic matters.
What an emotional business this is. The uneasy market sell-off continued today with option implied volatility climbing higher. Radio and TV experts have no problem pumping fear into the average investor’s head. Fright sells. RIP Wes Craven.
New traders make the big mistake of watching and listening for every clue to help them place the perfect trade. Only to fill their heads and lead them on with too many opinions to sort through that they feel too handcuffed to place a trade.
Market moments like today create great opportunity. While others are buying puts I have been selling puts inflated by a downward market and increased volatility. Most of the time for income but on stocks I wouldn’t mind owning that I believe are “on sale”.
Factual information from the media is always welcome. A spirited market discussion you may have with others is too. But when it comes down to forecasting or following the herd don’t let anyone lead you on. May the next voice you hear be your own. Be a contrarian.
As someone pointed out two posts back, I did tell everyone: “Follow along for a less wordy (because I’ve already explained it all) installation documenting the conclusion to this story pretty soon, as the story must end before the dates stamped on my only two current positions: Friday the 21st.”
So here it is, minus lots of words, because there’s not a ton to say other than when I opened, when I closed, and the prices (and the way I dodged being assigned a lot of shares at the associated strikes.)
A picture is worth a thousand words, but here are few on top of that, anyway: On August 11th, with SVXY in the low 90s, and on August 12th, with SVXY in the mid 80s, I wrote puts for the 85 strike and the 77.50 strike (respectively), both to expire on August 21st.
On August 19th, feeling that anything could happen between then and Friday (good one, huh?) I bought back all, thinking I was being overly conservative on the 77.50s, but doing it anyway, just to raise cash, and because eight cents seemed like a fair price to get out of harm’s way.
The funny thing is that Friday ended with both of those strikes cut through like a red hot surgical scalpel through butter. Even the 77.50s would have been assigned, had I sat there watching the market like a slacker watching TV. This is not to say I didn’t get into more trouble later (I’m expecting a Santa sack full of early Christmas presents this week), but this is the story of last week.
I ended the week $918 richer (see above.) Simple trade; not very challenging to monitor under stable market conditions; almost boring enough to fall asleep to. If only every trade could be so easy, right?
What a wild week! Perhaps the wildest we’ve seen in years, with a 5.3% plunge over the course of the first two days of last week more than wiped away by the 6.4% rebound seen over the course of the last three. We’re still in the hole by more than 5% since the pullback started two weeks ago, but given the swings we’re clearly capable of making now, that gap could be closed in just a couple of days.
On the other hand, volatility is a two-way street – we could just as easily be seeing new multi-month lows two days from now.
We’ll dissect the market’s key indices below, as usual, but also as usual, we want to paint a bigger picture using the broad brush strokes of economic data.
We got a fair amount of economic news last week, but none of it as curious or compelling as Q2’s second (of three) reading on GDP growth. Rather than GDP rising 2.3% last quarter as first expected, it actually grew 3.7%. It could change again with the third revision, but the number rarely changes between the 2nd and 3rd look.
GDP Growth Chart
Source: Thomas Reuters
This morning (Sunday) I got a request from Eric Thompson at Thompson Capital Management to look into streaks of backwardation in VIX. There are different ways to measure backwardation. You will hear pundits say we are in backwardation whenever VIX closes higher than the front month future. Most market participants like to look to the relationship between the first and second month future since that relationship has a direct impact on the volatility oriented exchange traded products (think VXX). I personally prefer a full comparison of spot VIX, the first month, and the second month future.
As of Friday VIX has closed higher than the front month future for seven consecutive days. The front month future has closed higher than the second month for six straight days and my method of comparing VIX to both the futures has been in backwardation for six straight days.
So how do these numbers stack up to history? The following tables sum things up nicely.
The top five streaks for VIX closing above the front month future appear in the first table. Back in 2008 (no surprise her) there were sixty eight consecutive trading days where VIX closed higher than the front month VIX future. The next closest streak was 21 times when occurred around the time of the May 2010 flash crash.
The second table is the one most people care about due to the impact on VXX. For those new to all this VXX is actually based on a strategy that holds the front two month VIX futures contracts. Each day VXX rolls a portion of the portfolio from the front month to the second month. When we are in contango, which means the front month is lower than the second month, the strategy is selling less expensive contract and paying more for the new contract. This actions is a drag on the performance of VXX. However, when the front month future is higher than the second month the performance for VXX benefits.
I love when I run numbers and am surprised by the outcome. Note the longest streak on this table is seventy six days and it occurred in 2011, not 2008. That outcome caused a double take on my part.
The final table shows the streaks for backwardation based on comparing VIX to the two near dated futures contracts. All these streaks occurred during the great financial crisis or the credit downgrade in August 2011 so not big surprise here.
So, regardless of how you measure it, we have been in backwardation for just over a week. History tells us that if the markets continue to be volatile we could be in this situation for seveal more weeks to come.
Once a month I leave CBOE for a couple of days and turn into a student attending a residency at Oklahoma State. I do my very best to leave the markets behind and focus on my studies. I did a pretty good job of tuning out what was going on toward the end of the week. This resulted in me being surprised that the Russell 1000 (RUI) gained almost 1% on a week over week basis with the Russell 2000 rising just over a half of a percent. Both are lower on the year, with large cap stocks slightly outperforming when using RUI and RUT and large cap and small cap proxies.
We experienced a ‘first’ this past week in the volatility oriented markets. A common method of comparing small cap versus large cap risk perceptions is on display with the diagram below. Those of us that spend a good amount of time focusing on volatility like to compare the CBOE Russell 2000 Volatility Index (RVX) level to VIX. Until this past week RVX had always closed at a premium to VIX, but that ten plus year streak was broken on Monday, Tuesday, and Wednesday.
I came across two bull put spreads in the RUT arena from Friday that are targeting the September standard expiration series (AM settled on September 18th). The first one was executed pretty early on Friday when RUT was at 1151.51. A trader came in and sold the RUT Sep 18th 1150 Puts for 27.10 and purchased the RUT Sep 18th 1120 Puts for 17.30 and a net credit of 9.80. RUT settlement over 1150 results in a profit equal to the credit of 9.80 while the worst case scenario would involve RUT settlement at or below 1120 and a net loss of 20.20.
The next bull put spread is more like a neutral to bull put spread. Toward the end of the day there was a seller of the RUT Sep 18th 1110 Puts for a credit of 12.75 who purchased the RUT Sep 18th 1100 Puts for 10.85 and a net trade credit of 1.90. This trade occurred as the RUT had moved to higher levels and was quoted at 1158.61. As seen below this trade has quite a cushion to the downside and as long as RUT is over 1110 at settlement the credit turns into a profit. A big move to the downside, placing RUT below 1100 would result in a loss of 8.10.
I’m depending on my aging mental capacity in lieu of spending the time to go through the last four years of VIX recap blogs for the following statement. I have no recollection of a shift in the VIX term structure curve that replicates what shows up below. VIX lost value on the week, while all the futures contracts moved higher. Last Friday, spot VIX ran up quickly at the end of the day, but the futures remained at lower levels. To get back to a more ‘normal’ environment, we needed either a drop in VIX or a rise in the futures pricing. We actually got both with the front month September contract gaining almost 23% while VIX dropped by 7%.
The next chart and table is relatively new to this space and is a depiction of VIX and the next five weekly VIX futures contracts. For an apples to apples comparison the contracts are consistently rolled. So Week 1 on 8/21 was the August 26th contract while Week 1 for 8/28 is the September 4th contract. Do note that a week ago the near term future was at a discount of 3.255 while this past Friday the near term future is basically in line with spot VIX (for the quants it is actually at a slight premium).
As the week came to an end, which could not have come too soon for most traders, there was a fairly aggressive bear call spread traded in the VIX pit. There was a seller of the VIX Sep 16 Calls at 9.00 who also purchased the VIX Sep 20 Calls for 5.94 for net credit of 3.06. The payout at September expiration along with where VIX and the September future finished the week shows up below.
At expiration the trade makes money below 19.06 and if we get a dip to 16.00 or below then both call options expire with no value and the trader gets to keep the credit of 3.06 that was taken in when the trade was initiated.
Under no circumstances does the week over week change in the VXST – VIX – VXV – VXMT curve tell the story of last week. There’s something worth noting, but last week is not done any justice at all if a line showing Monday closing prices is not included, therefore it is.
What strikes me as noteworthy about the week over week change in something that is very subtle on the term structure chart that appears above. Note that VXV and VXMT actually rose last week. That can be taken as an indication that option traders are still bracing for more downside in the equity market, however they aren’t concerned about near term price moves.
The little loved VIX of VIX (VVIX) popped up on Monday and screamed for attention. Unfortunately, with the exception of Adam Warner from Schaeffer’s Research, the all-time high put in by VVIX on Monday was kind of lost in all the other stats being thrown around after Monday’s equity market drop. The chart below shows the whole history of daily closing prices for VVIX and do note on the far left that line pops up about 20 points higher than the previous record high.
Giving credit where credit is due, Adam’s blog appears in the link below –
To quote a really smart guy, “VXX did what it is supposed to do” last week in conjunction with the dramatic move higher in volatility. A common complaint pops up when VIX rises and VXX lags, interestingly the opposite happened on a week over week basis. VXX is a mixture of September and October VIX futures, both of which were up over 20% last week.