The VIX and the Pre-FOMC + Post-FOMC Trades

Back in December 2008, in VIX Trends Around FOMC Announcement Days, I posted a chart of the average movements in the VIX in the ten trading day leading up to and following “Fed Days,” otherwise known as days in which the Federal Open Market Committee (FOMC) makes its policy statement announcement. Several long-time readers who recall that chart – and an earlier incarnation from VIX Price Movement Around FOMC Meetings – have recently asked for an updated version. With all eyes on the Fed’s statement and Ben Bernanke’s press conference on Wednesday, this seems like a good time to revisit how the VIX moves in the days leading up to and following FOMC announcements.

In the chart below, I have normalized VIX data going back to 1990 to make it easy to compare the mean daily changes in the VIX in the ten trading days preceding FOMC policy statement announcements as well as ten trading days following those announcements. The quick takeaway is that the data from the last five years has been consistent with the data as of 2008. There are still three dominant features in this chart:

1. a pre-FOMC VIX ramp in which the VIX tends to move up sharply in the three days leading up to the FOMC announcement and trend up more gradually 1-2 weeks in advance of the announcement
2. a sharp decline in the VIX averaging about 2.6% on the day of the FOMC announcement, with a gradual decline in the VIX of another 1.0% or so in the two days following the announcement
3. a sharp rebound in the VIX that starts three days after the FOMC announcement and persists until nine trading days after the announcement

Over the course of the past five years, the pre-announcement ramp in the VIX has been steeper during the three days prior to the announcement and more gradual in the week or so prior to that period. Also, recent history has seen the post-announcement decline in the VIX extending two additional days to now span four days following the announcement.

Of course there is no reason to expect that patterns which have persisted for the past 33 years to magically reappear for each FOMC announcement going forward, but I do believe that the historical pattern does say something about human nature, uncertainty and perceptions of risk.

It is worth noting that the biggest one-day jump in the VIX on a Fed day dates from February 4, 1994, when Federal Reserve Chairman Alan Greenspan surprised the markets by announcing a 0.25% increase in the federal funds rate, helping to lift the VIX 41.9% on that day. For comparison purposes, the next largest Fed day VIX increase was a 15.1% gain on March 15, 2011. While another VIX pop may be in the cards, history says there is a 72% chance the VIX will decline on Wednesday and that the decline should average about 2.6% or about 0.44 based on the current level of the VIX.

What is the trade here? While many will undoubtedly try to guess the direction of Wednesday’s move, the three other trades with a historical bias include:

1. an increase in the VIX in advance of Wednesday’s announcement
2. a continuation of any decline in the VIX from Thursday to Monday
3. a new uptrend in the VIX beginning on Monday or Tuesday and running through the beginning of July.

[source(s): CBOE, Yahoo, VIX and More]

Related posts:

• VIX Trends Around FOMC Announcement Days
• VIX Price Movement Around FOMC Meetings
• How to Trade Options Around Volatile Events (Barron’s)
• The VIX and the Fed
• VIX Expiration Straddles
• VIX Expiration Condors
• A VIX Butterfly Play
• Follow-Up to “A VIX Butterfly Play”
• Selling VIX Puts Pre-Expiration
• Lots of Premium Left on Last Day of Trading in VIX November Options
• A Conceptual Framework for Volatility Events

Disclosure(s): none

Using DXJ to Monitor Developments in Japanese Equities, Currency and Risk

Since Tuesday’s The Currency Carry Trade, DBV and Risk clearly resonated with quite a few investors who are struggling to put their arms around what is going on in Japan and what the implications are for U.S. equities and other asset classes, I thought I would follow up today by focusing attention on an important ETP that can be used as an indicator or for speculation and hedging: the WisdomTree Japan Hedged Equity Fund (DXJ).

As the name suggests, DXJ is designed to be long Japanese equities, with no exposure to fluctuations in the Japanese yen, due to hedging of the currency. As WisdomTree puts it:

“The Fund employs an investment approach designed to track the performance of the WisdomTree Japan Hedged Equity Index. The Index and the Fund are designed to provide exposure to equity securities in Japan, while at the same time hedging exposure to fluctuations between the value of the U.S. dollar and the Japanese yen. The Index and the Fund seek to track the performance of equity securities in Japan that is attributable solely to stock prices without the effect of currency fluctuations.”

While DXJ was launched back on June 16, 2006, it was not until January 15, 2013 that options began trading on this product. The introduction of options is particularly notable in that while DXJ’s price provides an aggregated view of Japanese equities net of currency fluctuations, one can also use the implied volatility data from the options prices to determine how market participants see the risk and uncertainty in currency-hedged Japanese equities going forward. The chart below shows a three-month view of DXJ, with 30-day implied volatility (red line) remaining above 20-day historical volatility (blue line) for the past five weeks, though these numbers have converged this week. Not surprisingly, options volume has picked up substantially in DXJ as of late and there has been a bullish bias (calls = green, puts = red) in that volume. What I find even more interesting, however, is that implied volatility in DXJ appears to have peaked on June 5^th.

With USD/JSP breaking below 94 earlier today, clearly there is a great deal of volatility in the yen that is being hedged away by DXJ. If one were to be interested in buying Japanese equities on the dip and also wish to eliminate the currency exposure found in the likes of EWJ, then DXJ is an alternative worth considering.

On the other hand, if one is interested in monitoring Japanese equities and currency movements in one issue and/or tracking the market’s assessment of risk and uncertainty (via implied volatility), DXJ could certainly be a useful tool for those purposes as well.

[source(s): LivevolPro.com]

Related posts:

• The Currency Carry Trade, DBV and Risk
• The Risk Library
• A Conceptual Framework for Volatility Events
• Forces Acting on the VIX
• St. Louis Fed’s Financial Stress Index
• Fukushima Daiichi and ‘Event Theta’

Disclosure(s): long DXJ at time of writing; Livevol is an advertiser on VIXandMore

ISEE Equities Only Index Prints Something Not Seen Since March 6, 2009

Put to call ratios are a permanent fixture in my indicator stable and something I have been writing about for a number of years, including an early 2007 effort, A Sentiment Primer (Long).

My perennial favorite of all the off-the-shelf put to call ratios actually inverts the traditional ratio: the ISEE equities only call to put ratio. This ratio only counts opening options purchases and excludes index and ETF products so as to provide a more targeted approach to divining what sort of speculative trades retail investors are favoring.

What got my attention yesterday was that in reviewing the components of my proprietary Aggregate Market Sentiment Indicator (AMSI) for the newsletter, I saw that the ISEE equities only call to put ratio closed under 120 (meaning less than 120 opening call purchases per 100 opening put purchases) for three consecutive days for the first time since March 6, 2009 – the date when the SPX put in its post-crisis bottom at 666 and began what has now been a bull leg that has lasted more than four years.  Not surprisingly, this kind of hat trick is typically associated with conditions in which stocks are extremely oversold and ripe for a bounce, as appears to be the case today and was certainly the case in March 2009.

For the record, the ISEE equities only call to put ratio is back in the middle of its traditional range today, most recently at 178, as the financial markets are discovering some sort of normalcy – at least outside of the context of the Japanese yen.

The chart below shows the ISEE equities only call to put ratio, using closing values for the past month, as of yesterday’s close.

Note that the ISEE ratios come in two other flavors: an index that is limited to index and ETF transactions; and an all securities index which combines the equities only data and the index + ETF data. Current and historical data for all three versions of the ISEE call to put ratios, as well as an interactive chart, are available at the ISEE Index page.

For those who may be interested in learning more about put to call ratios, I have a larger than usual list of links below to jump start your research.

[source(s): International Securities Exchange]

Related posts:

• New Single Day High in Equities Only ISEE Index on Monday
• Yesterday’s Unusually Low ISEE Equity Number
• Checking for Atheists
• Equity Put to Call Ratio Hits Ten Month Low
• Chart of the Week: Total Put to Call Ratio
• CBOE Equity Put to Call Ratio Poised to Print Warning
• A First Look at the ISEE
• A Sentiment Primer
• Chart of the Week: Total Put to Call Ratio
• VIX and Put to Call Ratio Snapshot
• Rohan Clarke on the VIX and Put to Call Ratios
• Interesting Chart Utilizing Put to Call Ratios and Volatility
• Put to Call Ratio and the Probability of a Downturn
• Put to Call Ratios and Volatility Predictions
• Put to Call Data at Extreme Levels
• CBOE Equity Put to Call Ratio Poised to Print Warning

Disclosure(s): none

The Currency Carry Trade, DBV and Risk

Anyone who has been active in the financial markets during the past five years knows that there are many types of risk, many ways to think about and measure risk, and invariably some risks lurking around the next corner that many of us have never bothered to contemplate. Most investors tend to focus their attention on equities and therefore have a tendency to think in terms of the CBOE Volatility Index (VIX) and use that number to evaluate the relative level of risk, uncertainty or perhaps fear in the markets. That being said, during the past few years, almost everyone has become conversant in such topics as credit default swaps, the TED spread, the LIBOR-OIS spread, bank capital ratios and a whole host of concepts and statistics which were not on their radar in 2007.

For a more holistic approach to evaluating risk, there is always the St. Louis Fed’s Financial Stress Index, which is one example of an attempt to aggregate a variety of risk factors (18 in all) related to economic and financial matters into a single risk index.

One aspect of market risk that many investors continue to struggle with is the currency carry trade. If the daily movements of the dollar are relatively unimportant for those interested in buying and selling stocks that are primarily based in the U.S., then it is relatively easy for most investors to conclude that the gyrations of the Japanese yen (FXY) or Australian dollar (FXA) can be dismissed as much less important than those of the dollar. Unfortunately, this is not always the case. It turns out that many investors, particularly large institutional ones, have an appetite for the currency carry trade, in which one borrows in a currency where interest rates are low and uses the proceeds to buy assets in a currency where interest rates are higher. With Japan’s central bank targeting interest rates of 0.1% and the Reserve Bank of Australia recently cutting its base rate to 2.75%, the carry trade is structured as an interest rate differential trade in which an investor can borrow in yen and then buy Australian bonds, with profitability determined by the net interest rate differential plus or minus any fluctuation in the exchange rate.

Naturally some more aggressive investors prefer to use the yen as a funding currency for the purchase of assets other than bonds, including U.S. stocks. The problem for investors in U.S. stocks is that when the yen appreciates sharply – as it did on Monday and Thursday of last week, as well as during today’s session – traders with short yen positions who are victimized by a short squeeze will be subject to margin calls and/or forced liquidations, which means that not only are they covering their short yen positions, but they are also selling any long positions in U.S. equities as both legs are unwound. For this reason, when the yen carry trade is in favor, U.S. equities tend to move in the opposite direction of the yen. Traders can monitor the strength of the yen by following the USD/JPY currency cross or the Japanese yen ETF, FXY.

An alternative to focusing entirely on the yen is to monitor the PowerShares DB G10 Currency Harvest Fund (DBV), which, as PowerShares indicates, “is composed of currency futures contracts on certain G10 currencies and is designed to exploit the trend that currencies associated with relatively high interest rates, on average, tend to rise in value relative to currencies associated with relatively low interest rates. The G10 currency universe from which the Index selects currently includes U.S. dollars, euros, Japanese yen, Canadian dollars, Swiss francs, British pounds, Australian dollars, New Zealand dollars, Norwegian krone and Swedish krona.”

In other words, DBV is a carry trade ETF that is short three currencies and long three currencies at all times, updating these holdings on a quarterly basis. The ETF is currently short the Swiss franc, the euro and the yen, with long positions in the Australian dollar, the Norwegian krone and the New Zealand dollar.

As the chart below shows, DBV has been tracking the S&P 500 index quite closely for most of the past year, but that relationship has recently broken down as DBV has plummeted while the SPX has experienced only a mild pullback. Going forward, investors should strongly consider keeping an eye on the USD/JPY cross, the FXY ETF (which is optionable) and also DBV, which provides a much broader picture of the overall carry trade – and can also serve as a proxy for the risk this trade can pose to stocks.

[In addition to the products referenced above, note that there is a currency carry trade ETF that is similar to DBV, the iPath Optimized Currency Carry ETN (ICI), but this product has considerably less liquidity.]

[source(s): StockCharts.com]

Related posts:

• Suppressing Volatility and the Black Swan of Cairo
• Thinking About Volatility
• The Credit Default Swap Canary
• The Risk Library
• A Conceptual Framework for Volatility Events
• Forces Acting on the VIX
• The St. Louis Fed’s Financial Stress Index and Market Risk
• VIX and St. Louis Fed’s Financial Stress Index Moving in Concert
• Zooming in on the St. Louis Fed’s Financial Stress Index
• St. Louis Fed’s Financial Stress Index

Disclosure(s): none

The Fed, QE, the Economy and Goldilocks 2.0

It was never easy being a central banker and the job has become much more difficult over the course of the last five years or so, but right now the task of guiding monetary policy and juggling the myriad of threats to economic stability is particularly daunting.

Take the Fed, for instance. The current policy statement calls for $85 billion of bond purchases each month, until the unemployment rate is below 6.5%, as long as inflation expectations do not rise above 2.5%.

At some point, however, the Fed will have to taper its bond purchases and ultimately begin selling some of its bond holdings. The big questions surround when to begin reversing course and how dramatic the increments will be in those policy changes.

With the unemployment rate and rate of inflation highlighted as the key data points for determining the timing and magnitude of the policy changes, the task of slowing and ultimately reversing the quantitative easing policy seems reasonably straightforward, at least in theory.

One big problem is that the unemployment rate may not be a very good gauge of the health of the economy. The chart below shows economic data reports relative to expectations over the course of the last 3 ½ years. Note that up until about a year ago, there was a very strong correlation between the performance of the S&P 500 index and whether economic data beat or missed consensus estimates. The correlation resumed when economic data turned up in the end of September, but a new divergence arose when economic data began stalling about two months ago, while stocks have been making new highs.

[source(s): various]

Looking at the five components of the economic data, one can see that for the past eight months or so there has been a favorable trend in housing/construction, employment, the consumer, and prices/inflation. As the graphic below illustrates, the one category that has been consistently missing expectations, particularly over the course of the last five weeks, has been manufacturing and general economic data, a category that includes reports such as GDP, ISM, Industrial Production, Capacity Utilization, Durable Goods, Factory Orders, Regional Fed Indices, Productivity, etc.

[source(s): various]

The problem for the Fed is that even though even though the consumer, housing / construction and aggregate unemployment rates all suggest an improving economy, the manufacturing sector and employment measures such as the labor force participation rate (official BLS graphic) paint a picture of continuing economic weakness.

As an investor, one has to guess how the Fed will handle this evolving conundrum. My general sense is that bulls will be rewarded if the economic data continue to fall slightly short of expectations and help to persuade the Fed that maintaining or perhaps even increasing bond purchases is the best policy approach – all of which should be a positive for stocks. Should economic data, particularly the employment component, begin to top estimates on a regular basis then we are left with the likely conclusion that the Fed will begin to remove the QE safety net relatively quickly. At the other end of the spectrum, if data fall well short of expectations going forward, the more perplexing conclusion is that even with its expanding toolbox, efforts by the Fed to prop up the economy are having at best a temporary effect and are also demonstrating diminishing returns. For investors, the data sweet spot going forward – or Goldilocks zone, if you will – is likely to be a series of near misses that extends the current policy indefinitely.

[Readers who are interested in more information on the component data included in this graphic and the methodology used are encouraged to check out the links below. For those seeking more details on the specific economic data releases which are part of my aggregate data calculations, check out Chart of the Week: The Year in Economic Data (2010).]

Related posts:

• Stocks and Economic Data Continue to Move in Opposite Directions
• The Economic Data Cliff
• Worst Post-2009 Week in Economic Data Relative to Expectations
• Stocks and Economic Data on Upswing Despite Disappointing Manufacturing and Housing Numbers
• Economic Data vs. Expectations: Stocks and Employment Data Rallying Since October
• Economic Data: Divergence or Confirmation for Stocks?
• Aggregate View of U.S. Data vs. Expectations
• How Good Has the U.S. Data Been Lately?
• Economic Data Not Supporting Gloom and Doom Forecasts – At Least for Now
• Economic Data Relative to Expectations and Stock Prices
• Continued Lackluster Data vs. Expectations
• Economic Data Frozen Until Next Thursday
• More Upticks in Economic Data vs. Expectations
• Economic Data Trends Improving
• Chart of the Week: Updated Economic Data Trends
• Economic Data Trends in Advance of Nonfarm Payrolls
• Trends in Economic Data Relative to Expectations

Disclosure(s): none

ETPs Turn to Selling Options to Generate Income

Not long after I penned The Options and Volatility ETPs Landscape, Credit Suisse (CS) added another buy-write / covered call ETP to the mix: the Credit Suisse Silver Shares Covered Call ETN (SLVO).

With SLVO, Credit Suisse is essentially extending the methodology they pioneered with the Credit Suisse Gold Shares Covered Call ETN (GLDI). In the case of both GLDI and SLVO, the ETPs are selling covered calls against the underlying commodity ETF for gold (GLD) and silver (SLV) in an effort to generate some income, and in so doing, choosing to forego some upside potential. In both instances, the ETP starts selling covered calls with 39 days until expiration and completes the sales with 35 days to expiration. One month later, the ETP buys these covered calls back over a period ranging from five to nine days prior to expiration. The net proceeds of these covered call transactions are then paid out as a monthly dividend. This dividend payment is not guaranteed and can fluctuate substantially from month to month. In the first four months following its launch, the monthly dividend for GLDI has been 0.1146, 0.0724, 0.1319 and 0.0572.

As silver is generally much more volatile than gold, SLVO elects to sell calls that are 6% out-of-the-money, while GLDI sells calls that are only 3% OTM. Other than this difference in strike selection or moneyness, the strategies employed by GLDI and SLVO are essentially the same.

Of course, covered call strategies work best when the price of the underlying is flat or when the underlying is appreciating slowly. During the recent sharp drop in GLD and SLV, the covered calls did provide a small amount of downside protection, but with GLD falling 13% over the course of just two trading days last month, the downside protection offered by a covered call was barely more than a rounding error. Covered calls and buy-write strategies generally outperform a long position in the underlying in all instances except when the underlying experiences a strong bull move.  (See graphic below for details.)

Thinking more broadly, the introduction of GLDI and SLVO should reinforce the idea that with ETPs now spanning a wide variety of asset classes and alternative investments, covered call strategies can be implemented in many non-traditional ways. The most popular of the traditional methods is PowerShares S&P 500 BuyWrite (PBP), which sells covered calls against the popular equity index. There is no reason, however, why there cannot be a similar product that sells covered calls against more volatile groups or sectors, such as emerging markets (EEM), small caps (IWM) or semiconductors (SMH), just to name a few. One can even bring alternative assets under the covered call tent. I’m not talking just about the likes of crude oil, copper or corn, but why not have covered calls on real estate, currencies or even volatility ETPs?

Better yet, why stop at covered calls? A strategy that I have discussed here on a number of occasions is selling cash-secured puts. The recent launch of U.S. Equity High Volatility Put Write Index ETF (HVPW) brought the put-write strategy into the ETP marketplace.  It is unfortunate that put-write strategies have not found a wider audience at this point or they too would be ripe for extending beyond the comfortable confines of the S&P 500 index.

Assuming this market eventually stops going up almost every day, investors are going to have to look for other ways to grow their portfolio and the scramble for yield will no doubt intensify. With ETPs now selling options to generate income, investors may want to look at some of the shrink-wrapped products mentioned above or consider how they might wish to implement similar strategies on their own.

[source(s): StockCharts.com]

Related posts:

• The Options and Volatility ETPs Landscape
• Opportunities Arising from Unusually Low Volatility in Gold
• Recent Developments in Gold and Gold Volatility
• Silver Volatility Rises Over 50
• Is Volatility a Better Play for Silver than Direction?
• Covered Calls Finish Strong in 2011
• The Value of Selling Covered Calls
• Surfing for Weekly Buy-Write Trades
• Sideways Markets, Covered Calls and the RUT
• BEP and the Joy of Covered Call Funds
• One Approach for Volatile Sideways Markets
• The Often Overlooked Put Writing Strategy
• Graphical Comparison of Performance of PutWrite and BuyWrite Indices
• More on PUT Returns

Disclosure(s): long GLDI and HVPW at time of writing

Guest Columnist at The Striking Price for Barron’s: How to Insure Your Stock Portfolio

Today’s guest column at The Striking Price on behalf of Steven Sears at Barron’s marks the tenth time I have had the opportunity to write a column for Barron’s and this time around I even managed to suppress the impulse to write about the VIX and volatility – at least directly.

In How to Insure Your Stock Portfolio I drill down on an element of hedging I cited in one of my hall of fame posts, Cheating with Partial Hedges. Specifically, I talk about bear put spreads, which I like to think of as “gap hedges” due to the fact that they offer protection should the underlying fall in between two strikes.

The Barron’s article talks about a specific SPY gap hedge strategy involving buying puts that are 5% out-of-the-money and offsetting some of the cost of the put protection (and capping the downside effectiveness) by selling puts that are 10% out-of-the-money. Done at a 1x1 ratio, this is a classic bear put spread that has the following effect on an SPY position:

[Graphic showing range of protection offered by 5% - 10% bear put spread or “gap hedge”]

What I didn’t have the space to discuss in the Barron’s article is the possibility of converting the 1x1 position into a ratio put spread by selling two 10% OTM puts for every one 5% OTM put that is purchased. With SPY closing at 154.14 today, the strike closest to a 5% pullback is 146, where the July puts currently at 2.55. At the same time, the 10% OTM strike is 139 and the July 139 puts are 1.40. With these numbers, a 1x2 ratio spread can be initiated for a credit of 0.25 (2x1.40 – 2.55) and provide protection down to SPY 139 (9.8% below today’s close) essentially for free. The big caveat here is that there is no such thing a free portfolio protection. What happens here is that in moving from a 1x1 put spread to a 1x2 ratio spread, the position is transformed from a limited risk position to a unlimited risk position where investors are exposed to the possibility of large losses should SPY fall below 139 prior to the July 20^th expiration. For this reason, put ratio spreads – or any options trade with unlimited risk – should be utilized only by advanced options traders. In contrast, the standard 1x1 put spread is an excellent trade for beginning and intermediate options traders to seek to master.

Related posts:

• Cheating with Partial Hedges
• Performance of Volatility-Hedged ETPs
• Why Not Point Hedges?
• Dynamic VIX ETPs as Long-Term Hedges
• Comparing SPLV and VQT
• Three New Risk Control ETFs from Direxion
• The Case for VQT
• The Year in Safe Havens
• The VIX as a Hedging Tool

A full list of my Barron’s contributions:

• How to Insure Your Stock Portfolio (April 18, 2013)
• The Case for Options Trading (January 2, 2013)
• Calm Down and Exploit Others’ Anxieties (November 14, 2012)
• How to Trade Options Around Volatile Events (July 10, 2012)
• Be Greedy While Others Are Fearful (May 3, 2012)
• Ways to Turn Volatility into an Asset Class (January 12, 2011)
• There’s Opportunity in Uncertainty (November 18, 2010)
• Will Market Volatility Return to Crisis Levels? (September 15, 2010)
• The Perils of Predicting Volatility (May 20, 2010)
• Take a Longer View on Volatility (July 2, 2009)

Disclosure(s): none

Four Years of SPX Pullbacks in One Plot

Each time stocks correct, I invariably receive requests from readers to update my SPX pullback summary data, as I did most recently on February 26^th in Updated SPX Pullback Summary Table for SPX 1485, after the S&P 500 Index had pulled back 3.0% from a recent high.

Rather than simply add another row to that table to capture the peak-to-trough decline of 3.5% from Thursday’s high of SPX 1597 and today’s early session low of 1541, I thought it might be more instructive to update an old plot of all twenty pullbacks that I have catalogued since the March 2009 bottom in stocks.

In the plot below, the y-axis captures the magnitude of the peak-to-trough decline (inverted) and the x-axis records the duration of that move. At the risk of making the graphic somewhat of an eye chart, I have also included the peak VIX during the pullback as a red label for each dot. Just for fun, the long dotted black line is a linear fit of all the data points.

I have annotated the data for some of the larger pullbacks and have also highlighted the current pullback in blue text. Some might find it interesting to note that with the VIX has exceeded 19.00 in every pullback with the exception of the 17.90 peak VIX value during the current pullback.

Of course there is no guarantee that the current pullback will stop at 3.5%, but if it does, it will certainly be one of the mildest pullbacks of the 2009-2013 bull market.

[source(s): CBOE, Yahoo, VIX and More]

Related posts:

• Updated SPX Pullback Summary Table for SPX 1485

Disclosure(s): none

The Low Volatility Story in Pictures

Lately I have not been able to help being bombarded by articles extolling the virtues of investing in low volatility (also known as minimum volatility) exchange-traded products. These ETPs typically talk about the tendency of investors to become overly enamored with some of the sexier, more volatile stocks and accordingly bid these up to unsustainable valuations. On the other hand, the tortoise-like approach to lower volatility stocks tends to avoid these stocks that are fashionable for short periods of times, so-called “story stocks,” momentum favorites, and stocks with hockey-stick charts that sometimes become mini-bubbles. Instead, plodding growth, dividends and total return are the main areas of focus.

I have discussed the most famous of these low volatility ETPs, the PowerShares S&P 500 Low Volatility Portfolio (SPLV) in a number of different contexts in this space, including:

• Performance of Volatility-Hedged ETPs
• Comparing SPLV and VQT
• SPLV vs. XLP
• Beyond SPLV: The Expanding Universe of Low Volatility ETPs
• The Options and Volatility ETPs Landscape

This time around my intent is to let the graphics speak for themselves, so without further ado, I give you three snapshots of the performance of SPLV against the performance against its more volatile sibling, the PowerShares S&P 500 High Beta Portfolio (SPHB).

SPLV vs. SPHB since inception (472 days):

[source(s): StockCharts.com]

SPLV vs. SPHB over the last 380 days:

[source(s): StockCharts.com]

SPLV vs. SPHB over the last 200 days:

[source(s): StockCharts.com]

I realize that every historical period in the financial markets is unique and that one can cherry pick graphics to make any imaginable point, but I think the three charts above tell almost the full story, which is this:

1.  Over the long-term, low volatility stocks have a high probability of outperforming high volatility stocks on an absolute basis and particularly on a risk-adjusted basis

2.  Even in bull markets, the total return approach of low volatility stocks often makes them comparable to or even superior to high volatility stocks

3.  The biggest risk associated with a low volatility approach is being left behind in a sharp bull move, when more defensive sectors can underperform substantially

The real question to ask yourself is which risk concerns you the most: a large drawdown or missing out on a large chunk of a bull rally?

Related posts:

• Beyond SPLV: The Expanding Universe of Low Volatility ETPs
• The Options and Volatility ETPs Landscape
• Comparing SPLV and VQT
• SPLV vs. XLP
• High and Low Volatility ETPs
• Performance of Volatility-Hedged ETPs
• Investing with a Target Volatility Approach

Disclosure(s): none

Another Record in VIX Call Volume

Exactly three weeks ago today, I thought I would break some news on an intraday basis with a post that I titled, Record VIX Options Volume and Large Purchases of VIX Calls. As it turns out, by the time the day’s total volume was tallied, February 26^th turned out to be an all-time record for VIX options volume in general and VIX calls in particular.

The events of three weeks ago now look a little less impressive in light of today’s new record in VIX call volume. Truth be told, VIX options seem to be attracting the attention of a new group of investors. In fact, during the CBOE Risk Management Conference earlier this month, there was a great deal of speculation surrounding who some of the new players in the VIX space might be that are responsible for the new growth in VIX futures and VIX options that appears to be independent of the volume driven by VIX ETPs.  [Hedge funds, proprietary trading firms, commodity trading pools/advisors, insurance companies, bond traders, FX traders and others were among the names that were bandied about…]

As is typically the case with the VIX, call volume outpaced put volume by a substantial margin. Today the call to put ratio was about 2.2 to 1, slightly higher than the average of 1.9 to 1. That being said, put buyers appeared to be a little more aggressive than call buyers, with 42% of all puts bought on the ask, as opposed to 30% of the calls, according to data provided by LivevolPro.

Investors are always looking for an interpretive overlay for these VIX options transactions. Frankly, on the day before the March VIX expiration, a great deal of the options activity is the result of large investors closing out March positions or attempting to game the special opening quotation (VIX SOQ) from tomorrow’s open that establishes the settlement price for VIX options and futures.  As a result of that low signal to noise ratio, the day prior to expiration is generally not a productive time for reading options entrails, though there will no doubt be some who are hell-bent on some sort of options divination regardless of where we are in the VIX expiration cycle.  For today at least, I would suggest that the links below might bear more fruit. 

Related posts:

• Record VIX Options Volume and Large Purchases of VIX Calls
• A VIX Risk Reversal
• VIX Puts Looking Attractive
• Selling VIX Puts Pre-Expiration
• A VIX Butterfly Play
• Follow-Up To “A VIX Butterfly Play”
• SPX Options Carpet Bomb Takes VIX SOQ to 63.04(!)
• Taking Profits in VIX Options (and ETPs)
• VIX Implied Volatility Exceeds 2008 Crisis Levels

[source(s): LivevolPro.com]

Disclosure(s): Livevol and the CBOE are advertisers on VIX and More

Lowest VIX Close Since Day Before Biggest VIX Spike Ever

I’m generally not one for sensationalist headlines, fear-mongering or otherwise stirring up trouble unnecessarily, but when facts line up in a manner that I know others will find interesting, I do feel an obligation to point that out.

So…at the risk of being splashed all over the Zero Hedge comments stream I thought it worth noting that today the VIX closed at 11.56. While this marks the lowest close in the VIX in over six years, a surprising portion of this low VIX is the result of a calculation quirk I described earlier today in The VIX, Interpolation and the Roll. In other words, I would characterize today’s VIX as artificially low and considerably lower than the near-term VIX calculation (VIN).

That being said, there is no denying that the last time the VIX closed below today’s close was February 26, 2007, the day before The Biggest VIX Spike Ever, a 64% jump in one day.

Do I expect a new record VIX spike tomorrow? Hardly, though I should note that just two weeks ago today we did see the #11 all-time VIX spike for a single day.

What is more likely to happen is that the negative coefficient for the weighting of the far-term VIX calculation (VIF) will slowly dissipate over the course of the week and that in itself should lift the VIX about three-quarters of a point. Throw in a just one or two days of declining stocks triggering the purchase of SPX puts for portfolio protection and it would be very easy to see the VIX up more than 20% from its current level by the end of the week.

Looking back at the concerns that dominated my fear poll a couple of months ago, most of these have dramatically receded. For this reason, it looks like it will take one of those unexpected threats to get the VIX airborne once again.

Related posts:

• The Biggest VIX Spike Ever: A Retrospective
• All-Time VIX Spike #11 (and a treasure trove of VIX spike data)
• The VIX, Interpolation and the Roll
• How Can the VIX Be 14 and Lower than VIN and VIF?
• VIN, VIF and an Obsolete VIX
• Investor Fears Pivot to U.S. Deficit and Debt Ceiling Following Cliff Deal

Disclosure(s): none

The VIX, Interpolation and the Roll

Almost every month, some subset of the class of investors and journalists expresses extreme alarm when the VIX magically plummets on the Monday before the standard monthly options expiration that occurs on the third Friday of every month.

I have written about this before, notably in:

• How Can the VIX Be 14 and Lower than VIN and VIF?
• VIN, VIF and an Obsolete VIX

The executive summary is that for most of its monthly cycle the VIX is an interpolated value derived from the first and second month S&P 500 index (SPX) options contracts. In an interpolation, one is presented with two values and attempts to derive a value that is in between those two, typically by drawing a straight line between the values and attempting to determine where on that line the desired value should fall. When one wants to derive a 30-day VIX and the SPX options contracts are, say, 17 and 45 days out, then a simple linear interpolation accomplishes that goal – and that is what the VIX calculation methodology does.

Things become more interesting due to the fact that the CBOE mandates that the near-term month used in the VIX calculation have at least one week to expiration. So what happens is that on Friday the VIX used the March and April expirations in the VIX calculation; today April becomes the near-term month and May becomes the far-term month. With the April expiration falling on April 19^th and the May expiration on May 17^th, this means the two months used in the VIX calculation have 39 and 67 days until expiration, respectively. So how does the CBOE arrive at a 30-day VIX value? Well, they still use the near-term VIX calculation (VIN) and far-term VIX calculation (VIF), but they accomplish this task by using a negative coefficient for the weighting of the far-term value, in addition to a coefficient that is greater than 100% for the near-term value.

There is nothing wrong with this approach and it delivers reasonable numbers when the near-term and far-term VIX have roughly the same value, but when there is steep contango in the SPX options term structure, which has frequently been the case over the course of the past two years, the resulting VIX calculation can be dramatically lower than both VIN and VIF. Right now, for instance, the VIX is at 11.71, while VIN is 12.48 and VIF is 13.50.

My suggestion would be not to focus too much attention on the VIX while the calculation uses a negative coefficient for VIF, which will be for the remainder of this week. Instead, those looking for a better gauge of what the VIX is should probably focus on VIN for the next four days.

Alternatively, one can refer to SPX implied volatility calculations provided by their options data provider, such as are incorporated into the SPX skew graphic below, courtesy of LivevolPro.

Related posts:

• How Can the VIX Be 14 and Lower than VIN and VIF?
• VIN, VIF and an Obsolete VIX

[source(s): LivevolPro.com]

Disclosure(s): Livevol and the CBOE are advertisers on VIX and More

Some Thoughts on the CBOE RMC

The 29^th Annual CBOE Risk Management Conference (RMC), wound down yesterday, proving that while Chicagoans and New Yorkers were happy enough just to escape the snow, there were some excellent business reasons for making the trip to southern California.

What I like to call the “VIX Summit” is no doubt the best place for VIXophiles to congregate, get acquainted, and exchange ideas related to a subject that tends to be arcane and poorly understood in most quarters, yet is increasingly embraced by a wide variety of practitioners. Nancy Davis of AllianceBernstein probably summarized best what is happening in the volatility space when she identified three trends that are driving institutional use of options:

1. New entrants
2. Cross-asset class opportunities
3. Structural differences

In terms of new entrants, the VIX product space is seeing a wide range of new institutional interest from hedge funds and proprietary trading firms to CTAs (commodity trading advisors), insurance companies and other firms, many with an international flavor. One of the common themes is the search for yield enhancement strategies. A lot of this activity can explain the recent surge in volume in VIX futures and VIX options. Whereas VIX ETPs had been driving volumes in VIX futures in the past, now growth is being driven by the participation by a broad range of new institutional players, some of whom are “curve hopping” from Treasuries to the VIX and many of whom are motivated by the lack of compelling alternatives to enhancing yield.

In these types of events there is always one presentation that catches you by surprise and gives you a lot of ideas to ponder that had not necessarily been on your radar. For me that presentation came from John Coates, the author of The Hour Between Dog and Wolf: Risk Taking, Gut Feelings and the Biology of Boom and Bust. In a wide-ranging talk, Coates has some compelling observations on physiological systems and how these are intertwined with everything from pleasure and addiction to expectations, uncertainty and risk assessment. Frankly, even if the subject of trading was not directly incorporated into this presentation, this talk still probably would have left me with more to chew on than the other presentations.

In the U.S., the RMC alternates between Florida in even years and southern California in odd years and is typically held during the last week of February or the first week in March. Last year a CBOE RMC – Europe conference was added in Ireland. The success of that conference has translated into a repeat performance that is scheduled for September 30 – October 2, 2013 at the Penha Longa Hotel in Sintra, Portugal, just outside of Lisbon. As a port fan who has never been to Portugal, I can certainly envision a trip to Portugal in September in addition to Florida next year.

Last but not least, thanks to all those I the pleasure of meeting this week.

[photo: near Big Sur, California]

Related posts:

• Best VIX Conference of the Year? Try the CBOE RMC
• The Upcoming 2012 CBOE Risk Management Conference
• The VIX Summit, a.k.a. the CBOE Risk Management Conference

Disclosure(s): the CBOE is an advertiser on VIX and More; VIX and More is a sponsor of the CBOE Risk Management Conference

The Options and Volatility ETPs Landscape

For several years I have publishing a graphical overview of the VIX ETPs landscape, with all the ETPs plotted on the basis of leverage and target maturity, such as the recent VIX ETP Returns for 2012.

Lately, however, an expanding crop of options and volatility ETPs has been taking root in a space that is closer to the VIX products than any of the other ETPs. I talked about the low volatility ETPs at some length in yesterday’s Beyond SPLV: The Expanding Universe of Low Volatility ETPs.

The graphic below is a plot of these securities, with the their geography, market cap and asset class in the rows and strategy/approach in the columns. I have talked about PBP in this space and was particularly interested to see that the buy-write / covered call approach is now being applied to gold in the form of the recent launch of GLDI.

Part of what prompted today’s approach is the launch of U.S. Equity High Volatility Put Write Index ETF (HVPW), which is the first put-write ETP on the market. I have talked about put-write strategies and the CBOE S&P 500 PutWrite Index (PUT) at some length here in the past and have included some links below for additional reading.

In the convertible bond space, CWB has been the most popular ETP in this space for the last few years. Earlier this week, PowerShares closed its competing Convertible Securities Portfolio ETF (CVRT), essentially ceding this space to CWB for now.

The other portion of the graphic below is my attempt at translating much of yesterday’s text into a format that makes for a more handy reference.

I will keep tabs on all of these ETPs going forward and in particularly look to see how HVPW and GLDI do in terms of both risk-adjusted performance and investor acceptance. I certainly hope it does not take investors as long to discover these products as it did for them to warm up to the likes of ZIV.

Related posts:

• Beyond SPLV: The Expanding Universe of Low Volatility ETPs
• VIX ETP Returns for 2012
• Covered Calls Finish Strong in 2011
• The Value of Selling Covered Calls
• Surfing for Weekly Buy-Write Trades
• Sideways Markets, Covered Calls and the RUT
• BEP and the Joy of Covered Call Funds
• One Approach for Volatile Sideways Markets
• The Often Overlooked Put Writing Strategy
• Graphical Comparison of Performance of PutWrite and BuyWrite Indices
• More on PUT Returns
• CWB: A New(ish) Convertible Bond ETF
• Comparing SPLV and VQT
• High and Low Volatility ETPs

Disclosure(s): long PBP at time of writing