One Size Doesn’t Fit All

When shopping for shoes there’s a need to know what size to purchase or I suppose one could say whatever comes close.

Performances between the U.S. small-cap and large-cap indexes have been quite different so far in 2016.  The small-cap as measured by the Russell 2000® Index (RUT) is down -14.66% compared to the large-cap S&P 500 Index -9.32% (based on closing prices 2/8/16).

RUT’s daily moves have been over 1.00% almost two-thirds of the trading days as illustrated below.1

Managing risks is not a simple task when volatility is rising.  The key is to find an effective hedging strategy offering protection with a non-correlating asset.

CBOE Russell 2000 Volatility Index (RVX)

The CBOE Russell 2000 Volatility Index (RVX) measures the (30-day) expected volatility in the Russell 2000 and carries a negative correlation to the Russell 2000 Index (-.831)*.  RVX has closed higher in the last 7 consecutive trading days and is +46.19% y.t.d.

2*Source: Bloomberg

RVX vs. VIX

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BigTrends.com Weekly Market Outlook – Hanging By A Thread?

Although stocks were never significantly into profitable territory at any point last week, at the very least on Thursday it looked like we might stabilize with just a very minor loss.  The bears had other plans on Friday, however, sending the market 1.85% lower that day to the lowest close in nearly two weeks.

And yet, it’s worth noting that neither the S&P 500 (SPX) (SPY) nor the NASDAQ Composite (COMP) broke under their most critical floors; we’re still not past the point of no return yet. (We are, however, getting close to that point again.)

We’ll explore it all below, as usual. But first, let’s run down last week’s and this week’s key economic numbers.

Economic Data

There was plenty of economic data to sift through last week, but there’s no doubt that the highlight was Friday’s jobs report for January. The Department of Labor said the unemployment rate finally edged the below the high 5.0% level to reach 4.9%.

Unemployment Rate Chart
020716-unemployment-rate

Source: Thomson Reuters

The DOL also said we added 158,000 new payrolls last month, falling short of the expected 183,000, and coming in well below December’s to 251,000. Nevertheless, we’re still into our sixth straight year of net job growth for each month of the year… even if some of those months were “just barely.”

To the extent it matters, the ADP employment change report from earlier in the week said we added 205,000 new payrolls last month, topping that estimate for 190,000. Point being, we should probably be viewing data that’s on the fence in a glass-half-full light.

The other big item worth a closer look from last week are the ISM indexes – manufacturing and services.

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Market in Distribution Continues

We started a new month this past week, but it was like déjà vu all over again.  The Groundhog declared an early Spring on Tuesday, a change in weather.  But regarding markets, you could have fooled me.  It was the same action we have seen for weeks on end, and it doesn’t seem to be letting up.  The vicious selling last week was magnified on Friday after a jobs report that seemed indicate the Fed may be trapped.  I’m not so sure about that, but the market speaks louder than my opinion. The stock market is under severe distribution, and it doesn’t appear to be ending any time soon.

In a bear market there is no stock that goes untouched.  It may take some time eventually the selling hits everything in sight.  Some of the most favored names over the past few years, like the FANG stocks (Facebook, Amazon, Netflix and Google) have been hammered since the start of 2016.  No surprise really, strong stocks become a source of funds.  Bear markets are like dark clouds that spread completely but very slowly.

Institutional selling is distribution, and is quite apparent when we look at metrics, sentiment and indicators.  Since peaking in 2014, breadth (daily accumulation vs distribution) has been on the decline.  Did that start the bear market?  No, but it certainly contributed.  The evidence has been cumulative, and the indicators have been lining up – bullish percent index has been falling since early 2015 (negative divergence), put/call ratios have been elevated, market volatility has been steadily rising since 2014 (all VIX futures contracts are above 22 now).

http://www.tradingvolatility.net/p/datasourceurldocs.html VIX Term Structure – Tradingvolatility.net

Institutions move stock prices — they move them BIG!  So, it makes sense to follow the big money and how it is flowing.  Some of the best tools around, such as the Chalkin Money Flow, on balance volume, McClellan Oscillators and momentum indicators tell us EXACTLY what is happening with institutional flow.

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Weekend Review – VIX Options and Futures – 2/1 – 2/5

Friday provided our first glimpse into how the economy was faring in January and the stock market apparently didn’t like what it saw.  VIX finished the day up 7% which was just under half the over 15% rise we got last week.  The February future managed an 11% gain to finish higher than spot VIX.  However, backwardation is still in place with the February contract higher than the March contract.  More on this after the chart and table below.

VIX Curve Table

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Weekly Review – Volatility Indexes and ETPs – 2/1 – 2/5

VIX rose last week as did the rest of the volatility indexes that based their levels on S&P 500 Index (SPX) option pricing.  Usually in times of panic VXST (9-day volatility) rises above VIX (30-day volatility), but that was not the case this past week.  You can read this two ways – traders think stocks will rebound or traders are mentally prepared for more downside in the market.  I’m leaning toward the latter.

VXST VIX VXV VXMT Curve

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Weekly Review – Russell 2000 Index and Options – 2/1 – 2/5

Small cap stocks continue to take it on the chin as the Russell 2000 (RUT) dropped almost 5% (4.81% for the quants) last week while the Russell 1000 (RUI) was down 3.16%.  I love how I am conditioned to a 3% drop in a broad based index feeling kind of normal.  My how times have changed.

RUT RUI

In times of panic the implied volatility of S&P 500 (SPX) options often elevates compared to the implied volatility of RUT index options.  That has not been the case in 2016 and in fact VIX closed at the biggest discount relative to RVX in almost two months this past week.  I see dual reasons, complacency despite equity market weakness and more concern about small caps than large caps.

RVX VIX

I went fishing for trading examples this past week and focused a bit on Thursday since the employment number came out Friday.  Another out of the money put spread seller showed up at the RUT post on Thursday when the Russell 2000 was trading around 1009.  In a couple of different transactions there was a seller of the RUT Feb 19th 950 Puts for 4.00 who purchased the RUT Feb 19th 850 Puts for 0.30 and a net credit of 3.70.  For full disclosure these numbers are round estimates as the trade was executed over the course of time and at different prices.

RUT PO

Note the downside cushion, based on RUT at the time is over 6%, therefore as long as the Russell 2000, which was already down over 10% on the year does not give up another 6% in two weeks this trade turns out fine.  However the market action on Friday places RUT closer to the all-important 950 level for this trade.

The Weekly Options News Roundup – 2/5/2016

The Weekly News Roundup is your weekly recap of CBOE features, options industry news and VIX and volatility-related articles from print, broadcast, online and social media outlets.

VIX: Overnight Access Granted

CBOE announced this week that it will begin overnight dissemination of the CBOE Volatility Index next month, enabling market participants to “view volatility during that period through the same lens used in regular U.S. trading hours.”

“CBOE Extends VIX Index Overnight for Non-US Firms” – Luke Jeffs, FOW

http://bit.ly/1NPHiQV

Coming Soon… “Wednesday Weeklys”

CBOE announced this week it plans to list SPX Wednesday-expiring Weeklys options beginning February 23. The new contracts will increase opportunities to trade SPX.  The Wednesday expirations also align with VIX Weeklys futures and options expirations, providing flexibility for customers who use both SPX and VIX product suites.

“CBOE Set List SPX Wednesday-Expiring Weeklys Options” – John D’Antona Jr., Traders

http://bit.ly/1o5JgIa

“CBOE to List SPX Wednesday-Expiring Weeklys Options” – Hedgeweek More

VIX Measures of Volatility Boosted by Muddled Economic Outlook

TYVIX Update Header (1)

Figure 1. TYVIX, VIX and Foreign Exchange Volatility Indicators

1

VIX volatility indicators for Treasury, equity and foreign exchange markets edged up this week as central bankers and investors appeared equally bemused by the crosscurrents in global economic news. Adding to ongoing concerns about China, low commodity prices, lack of inflation and lackluster growth, yields on sovereign bonds in Europe and Japan turned negative. Negative yields are sometimes viewed as a possible precursor to recession. The Bank of England is not expected to raise UK interest rates, and the date of a U.S. rate hike by the Federal Reserve is receding. The 10-year Treasury yield is still positive, but decreasing. On the other hand, many economists remain sanguine about the U.S. economy, in spite of slower employment growth and anemic spending by consumers and manufacturers. More

Block Trade Analysis – Bearish SPX Trade in Front of Employment Report

Tomorrow we get the first look at how the economy fared in January.  This insight comes with the release of the January Non-Farm Payrolls number.  I went searching for a trade or two executed late Thursday that may indicate a bullish or bearish market outlook in front of the number.

I didn’t have to look too much to find an interesting trade..  Just before the SPX option market closed at 3:15 pm Chicago time there was a buyer of about 500 SPX Feb 26th 1920 Puts at 41.70.  Note the payoff diagram below that shows a break-even level a little less than 2% lower than Thursday’s close.  In addition, I decided to highlight the S&P 500 closing low of 1859.33 for this year as well.  My thinking is that the trader behind this trade is speculating on new lows for the S&P 500 between now and February 26th or they are hedging a portfolio just in case.  Either way the employment number should give a hint as to the potential outcome for this trade.

SPX PO

Earnings Next Week – 2/8 – 2/12

Earnings season is approaching the end of the heavy period, but there are plenty of companies left to report.  The numbers below represent three years of history with a couple of exceptions which have not been around long enough to provide a full three years of history.  In those cases the data appears in italics.   After the ticker the columns show the biggest gain, biggest drop, average move (non-directional) and stock price reaction last quarter.

Earnings

Open Interest for Options on MSCI Emerging Markets Index (MXEF) Tops 600 Contracts

This last week the open interest for options on the MSCI Emerging Markets Index (MXEF) rose above 600 contacts for the first time. Over the past year several institutional investors have expressed interest in the potential for a liquid MXEF options contract, particularly because the MXEF options contract is cash-settled and has a notional size that is about 24 times larger than options on the EEM ETF.

VOLATILITY SKEW FOR MXEF OPTIONS

The volatility skew chart below shows that Bloomberg has estimated that the recent 30-day implied volatility was higher for MXEF than for the MXEA and SPX options at all nine strike prices shown; this fact could appeal to options writers who wish to generate more premium.

MM1

PRICE CHARTS OVER THE PAST YEAR 

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Trading Tactics: How to Deal With a Slump

Self-realization is a good place to start in breaking a trading slump.  I know it seems obvious that when you’re in a slump and trading poorly your results and account balance will reflect it.  Streaks work both ways of course, and when we are winning it is just as notable as when we are losing.  Understanding what is happening to you is awareness that may help you change some habits, which may also change your fortunes.

When in a slump I will often take a break from trading, a ‘timeout’.  Stepping away is a way to force myself to stop and reset my mind.  Although I may miss opportunities during that break, it doesn’t matter. The slump has crept into my mind and that is what needs to be removed.  One winner may help but stepping away for a bit and returning is a much more needed approach.

While taking a pause, I will often look back at recent trades – wins and losses to see if there is a pattern.  I will use my trading journal, the most valuable tool in my toolkit to search for clues.  Am I trading wrong?  Were conditions bad?  Should I have been quicker on the trigger?  Was I trading too much?  This self-analysis is worthy feedback, but more importantly I will address the issues and write down corrective steps.

Practice is always the best way to build confidence.  In trading, we like to paper trade, rack up a few wins and build confidence.  Of course, we don’t make money but if something we are doing is structurally wrong, then at least we didn’t lose money and we can look to overhaul our approach.

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Weekly Review – VIX Futures and Options – 1/25 – 1/29

The VIX term structure is approaching contango which many VIX watchers will consider a green light for the equity markets, but the February contract stubbornly remains elevated relative to the March contract.  Although on Friday this premium was down to 0.30.  My feeling is February may stay up a bit until we get the employment number behind us this coming Friday.  At that point I guess VIX will be just like the Fed (data dependent).

VIX LT Curve

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