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Summer Volatility – Will it Vanish?

Posted by Scott Murray on May 16, 2018
Posted in: Uncategorized. Tagged: Options, trading, VIX, Volatility.

The question traders are asking themselves right now is if it’s time to concede long vol trades for a while and pack it in, buy some XIV and call it a summer.

(Damn, XIV is gone. Ok, SVXY then. Ugh, it’s been neutered to .5x return of XIV. Ok, short some VXX and hit the links. What, why can’t I get a borrow? What the hell happened in February anyway?)

Let’s look at the last 5 years of summer volatility, at-the-money:

VOLI is the Voldex at-the-money implied volatility index. Basically, it’s a vix that measures 30-day implied volatility on options that are so close to price that they aren’t being used as insurance for tail risk events. For this reason, to me it can be more representative of the volatility environment. Short it and you can get ruined. Long it and you may bleed to death… but you could at any moment be lighting a cigar over tartare and delmonico while splurging on single malt islay.

Back to reality. What is clear is that in the last 5 years, these red-lined areas (Late May to late August) are when volatility has been most likely to hit its nadir for the year. 2017 was a freak show, we all know that now. But spikes in at-the-money vol could easily hit serious levels, and these are low compared to the vix. The most likely time for volatility to absolutely crater is a week or so in front of July 4th, when the double whammy of the holiday and expectations for non-correlated market moves due to earnings weigh heavily.

So don’t mail it in for the summer. June, July and especially August frequently saw real vol spikes near volatility low points for the year. Keep your phone in the cart.

 

 

Creative Volatility Trading (Part 1) – Calendar Ratio Spreads

Posted by Scott Murray on May 16, 2018
Posted in: Uncategorized. Tagged: calendar spreads, futures options, Options, ratio spreads, VIX, Volatility.

When most folks think about trading volatility, they immediately look to VIX, VXX, UVXY, SVXY and all the exchange traded notes and funds that are not only misunderstood, but that also on occasion blow up accounts or seriously damage portfolios large and small. It’s not just retail traders that get caught in volatility storms, there are plenty of large traders that do inopportune things as well. Most of the problem stems from not doing simple homework of what the index or funds are tracking, but also following the herd, back-testing on a bias, and expecting the recent past to repeat infinitely.

But trading volatility takes many forms, and you certainly don’t need to resort to those vehicles. Just going to the source of what the volatility derivatives are based on, SPX, can give you all that you need to extract some premium from the market with a risk/return profile that is probably better than dealing in the vix futures fund space. Let’s examine a structure that is rarely if ever found in the textbooks and is a short and long volatility trade combined.

Calendar put ratio:

Short May 25th ES- E-mini S&P 500 puts at the $2680 strike

Long May 31st ES – E-min S&P 500 futures puts at $2680 strike

Ratio of short to long puts, 2-1

This is a short volatility trade, but one that can withstand a pretty nasty down day without causing major problems. The reason for this is two-fold. First, you are selling higher priced premium as measured by implied volatility in the nearer term puts. The volatility in this trade is slightly backwardated – the implied in the front is higher than in the back.  Second, rising volatility has a larger effect on longer-term puts, as they have more time to expiration. The backwardated vol can be seen in the chart below:

The volatility for this week was highest, a bit lower for May 25th, and lower for May 31st. Aiding this structure is the Memorial Day holiday.

If you look at how this trade handles rising volatility, look at this chart:

Looking a week out and stepping up the volatility by 2% from 14 to 22 (on May 23rd as shown in this chart), the profit and loss diagram looks relatively the same at all five 2% interval steps. That is the effect of owning longer dated puts, even though you are short twice as many shorter dated puts. The risk to this volatility assessment would be if backwardation were to become extreme, then the potential loss would be larger. You can’t have it all in a trade, there is going to be a way to lose. But the risk here is quite balanced relative to the return.

Doing this for trade with 4 contracts short and 2 contracts long yields an $800 credit, as the shorts were sold for $12.50 and the longs purchased for $16.50.

Because of the structure, there are several paths to victory. A. The market could go up as far as it wants, you keep the $800. B. The market goes nowhere, you keep the $800 and sell the 2 remaining puts on May 25th for what they are worth, an additional credit. C. The market goes up and then on May 25th some quantitative tightening sends the market heading down and back to the original price of 2700ish. (Some is scheduled on May 25th, how fortunate.) Implied volatility rises and you sell the remaining 2 puts for $10 or more. That would net you another $1200 on top of the $800 initial credit.

In the last scenario, you are suddenly long volatility! You can be both long vol and short vol in the same trade and do absolutely nothing until you close it out.

For more volatility insights and trade ideas, see the subscribe tab at the top of the page for newsletter samples. Feel free to DM on twitter – @volatilitywiz

Trading Volatility in a Low Vol Market

Posted by Scott Murray on May 3, 2017
Posted in: Uncategorized.

One of the problems with getting long volatility using volatility exchange traded products when the VIX is 10 is that they still hold a significant premium to spot VIX. And when vol is low and it has been low for a while, these ETPs and their options are stubborn to accept that vol may or will move higher. The market has reason to be skeptical, no mini-dip in recent times has turned into a majo-dip in as long as the new short-VXX-everyday geniuses can remember being on the short-vol gravy train to profits-apalooza.

That doesn’t mean that long vol traders need to sit there and suffer all the time. While you wait for the perma-bulls to take a pie in the face for a change and the short-vol tourists to try to wrangle out of their short UVXY leap calls for a 50% daily loss one day, you can make friends with theta’s evil step-brother…gamma.

Take today for example, a mere 9 point drop in the SPX did this to an option that was already in-the-money at the start of the day. If you wanted to be long some vol without paying for decay, you could have owned this Wednesday 2390 SPX put off and on all week and kept riding it to gains:

Meanwhile, this is what price action you got with a VXX in-the-money $14.5 put that expires Friday:

Not much meat on that bone, especially after paying your round trip fee and commission tickets to TD Ameritrade for 20 cent options. Because a VIX at 10 has SPX at-the-money options at 6 implied volatility, the gamma works fast, whereas VXX still has the futures near 12, a buffer of premium that is not kind to the long option deltas.

So, something to consider when you want to get long some vol cheap, do it the ole fashioned way and hit the indices up for a change.

 

 

How Much Short-Term Downside is Left in VXX and UVXY?

Posted by Scott Murray on April 26, 2017
Posted in: Uncategorized.

It has been carnage in the long volatility ETP space this week (or pure delight being short these products or long inverse volatility ETPs) after the French election pollsters got it right and the VIX/futures immediate cratered to lows not seen since before the financial crisis. Here is a 5 day performance chart of a few major vol products:

But here is a scary thought- is it actually possible that you can be long these products and not expect to get killed? Maybe even make a few bucks on a down day? What a contrarian idea!

To answer that question, let’s examine what VXX is holding:

So with one week having gone by in the rolling cycle of VIX futures ETPs that hold the front month and roll into the second month, like VXX, it is approximately 1/4th June and 3/4ths May. So 75% of the performance of VXX is still tied to the May futures contract. The May and June contracts are currently priced 12.3 and 13.2 as we can see courtesy of @vixcentral.com:

One huge point to be aware of before we continue. Once about every 3-4 months the VIX rolling cycle, just like the options expiration cycle, experiences a 5 week roll. That is the case with June. June has 56 days to expiration.

So, let’s be realistic here for a moment. There just aren’t that many VIX settlements below 12. In fact, with all the record low realized volatility in the S&P 500 this year, the lowest settlement was 12.26 in February. In 2016, December expired in front of the major holidays at 11.15 and July settled at 11.62. So for the sake of this back-of-the-envelope math, 11 is really the lowest the VIX future can be expected to go. (Please don’t troll me if we print a 10.99 in May, anything is possible but you get the point here.)

If the front 2 months of VIX futures came off 10% tomorrow sending the May VIX future to 11.1 with 21 days to expiration, and June to 12 with 56 days to expiration, can we reasonably say that is about as far down as the futures can go in the short term (next 2-5 weeks)?

If you believe the rough math (don’t rely on my calculator, pull yours out), then VXX less 10% is $13.5 and UVXY at double that at -20% sends it to $12.10. That gives you something to shoot against. And the options know it too, the VXX May 19th $13.5 puts are a mere 7 cents!

 

 

Volatility Analytics Newsletter Returns

Posted by Scott Murray on April 25, 2017
Posted in: Uncategorized.

The Volatility Analytics Newsletter is back. Published every Tuesday evening, it is new and improved incorporating subscriber requests for more trades, basic instruction and information for new volatility traders, and charting. A sample is available here:

VA newsletter Apr24

This is a dynamic publication, always changing to accommodate the volatility topics and issues of the day facing the markets. It will also add sections that the readers feel need to be addressed.

Included with the subscription will be frequent nightly notes on volatility happenings, and the option to direct message me on twitter for questions and discussion on volatility topics and trading thoughts.

Volatility in November Historically Peaked Yesterday

Posted by Scott Murray on November 10, 2015
Posted in: Uncategorized.

Below is a chart depicting the mean and median performance of the VIX going back to it’s inception in 1990. I prefer to focus on the median (most bloggers and media focus on the mean, which I believe is skewed higher due to enormous jumps during certain crises) to get an idea of where the midpoint of VIX data sits historically during the options expiration cycle:

2015-11-04 15_09_39-Microsoft Excel non-commercial use - VIX-Wave-2012-11-29c

As you can see, yesterday was clearly the median high point for volatility historically since 1990, and the market cheerfully obliged by selling off. Why does this happen? One can speculate using the Stock Traders Almanac, and simply looking at how the market tends to perform heading into the middle of November. From a common sense perspective, the majority of earnings have passed, the news is out, and the market tends to fatigue. Individual shorts can re-enter, without earnings risk being in the way. Institutional investors tend to buy on the first day of the month as well, supporting early November performance.

As readers of my former newsletter knew, this was one  of my superb tools for trading not only SPY options, but VXX, SVXY, and UVXY options as well. One key in the process of entering good risk/reward scenarios is to create a mosaic with a tool kit of excellent and proven data models, and this is an example.

This is far from predictive, no single historical data tool is. We could have an earthquake in California next week, (one of my bigger investing fears, btw) that would render this useless. But that is an entirely different point that strikes to risk management.

 

VIX Expiration Nearing as NYMO shows 2nd Highest Level of the Year

Posted by Scott Murray on August 18, 2014
Posted in: Uncategorized. Tagged: nymo, VIX, Vix futures, volatility trading, VXX.

VIX expiration is clearly playing by the book this month, and it certainly appears that 2 million calls will expire worthless. With markets trading on minuscule volume, a pin of 13 is looking almost easy which would burn another 500k+ puts under 13 as well. What happens after Wednesday and as September approaches is anybody’s guess, but here is a clue about what could occur:

vix818a

 

The next two days I will be moving things around to prepare for the next cycle. (This week’s newsletter will be out tomorrow at around 10pm.) If the market wants to march higher in a straight line tomorrow, that will make things easier and offer the best prices.

Meanwhile, the NYMO is showing short-term overbought levels:

nymo818

The NYMO is the black line plotted against the SPY. The high for the NYMO in 2014 was 68 in February (just before Feb’s VIX expiration, shocking), and while it does not portend of a drop in the S&P 500, it does usually mean that some sideways action is in order at a minimum.

If the market does turn lower after Wednesday, it will be interesting what the media invents for a reason this time….

VIX Expiration Has Been Very Kind to SPX Longs

Posted by Scott Murray on August 15, 2014
Posted in: Uncategorized. Tagged: VIX, Vix futures, VXX.

VIX options and futures expire the Wednesday before or after monthly equity and index option expiration (The third Friday of the month). Once every three or four months it happens on the Wednesday after, like this month, but generally it is the Wednesday before. I have often suspected and have some data to support this suspicion, that the market has a strong bias to the upside during VIX expiration. Why? Because an enormous number of VIX calls would expire worthless. Don’t believe me? Look at just the past 12 expirations:

vixexpret

 

This average daily return is .55%, as compared to .03% for all days since 1950. I will have more data going back a few more years soon.

Meanwhile, the September VIX future, which is 90% of the short-term VIX ETNs now, is nearing support:

2014-08-15 07_54_32-_VXU4 - Quick Chart Main@thinkorswim [build 1864.10]

 

I’m eyeing Monday and Tuesday as the time to start some long vol positions.

VIX Plummets – Drags September Future Down To July Levels

Posted by Scott Murray on August 13, 2014
Posted in: Uncategorized. Tagged: uvxy, VIX, Volatility, volatility trading, VXX.

In four trading days, the sentiment has gone from “the correction is finally here, the world is totally unstable”, to “the Fed can’t raise rates because the consumer is in trouble”. Is one of those supposed to be good news? Here is the truth: Retail sales rose 3.7% over last July. (month on month results are great headlines but miss the point) The economy is doing fine and nothing has changed. Meanwhile, historical patterns and typical 3rd week OPEX cycle volatility occurred, almost as if it was by script.

The VIX September future dropped by 6% to levels seen before the sell-off:

sepvx813

 

As the VIX fell to 13:

vix812

The VIX futures curve steepened, and contango magically reappeared:

2014-08-13 18_49_04-VIX Term Structure

The SPY has retraced 50% of the drop, making Fibonacci fans excited:

2014-08-13 18_51_05-SPY - SharpCharts Workbench - StockCharts.com

So for the bulls, it appears to be all systems go for now. Our short positions on long vol have evaporated in a couple of days, and it is time to start looking at the other side of the coin. I started nibbling at selling premium on short volatility today, knowing that these bull moves can play out for a while. If nothing more, I’m establishing some hedges.

The middle of August into OPEX and just beyond historically sets up bullish, so lets see if this year continues to play by the book.

This week’s newsletter was published last night and the link to subscribe is above.

 

 

VIX Falls 10% – Futures Curve Steepens

Posted by Scott Murray on August 11, 2014
Posted in: Uncategorized. Tagged: VIX, VXX.

There was no news of significance today, and European markets led the U.S. into a higher open. That open was almost precisely where we closed, and since the S&P 500 was up around 12 pts at the high, a 6 point advance from open to close formed a shooting star candle. A lot of traders love to call this a bearish reversal or ugly candle, but the data does not support that. Bulkowski’s data demonstrates that it is merely a random probability what follows a shooting star:

http://www.thepatternsite.com/ShootingStar.html

The VIX took the lack of bad news pretty hard as it fell to around 14. Today had the feel of a typical summer session, with low volume and low volatility the characteristics of the day. The VIX term structure steepened and contango widened in the front months of the VIX futures curve:

vixterm811

Meanwhile, this was the trip for the September future. This is the only thing that matters now for VXX and UVXY holders, as it dominates their holdings:

vxsep811

This kind of action in the primary long holding in UVXY did some damage to the UVXY short $100 calls, which of course worked well for subscribers:

uvxy100811

The VIX reached July 30th levels:

vix811

Our next letter for subscribers will be published tomorrow night. I anticipate a few new trades this week, and we are on quite a roll lately….

Click the link above to subscribe to the newsletter for $25/month.

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