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VIX Moves Higher on… Cyprus??

Posted by Scott Murray on March 18, 2013
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Insolvent Cyprus banks were the talking-head points today, in what was a comical display of ignorance and ineptitude by TV pundits and political leaders. CNBC actually had the google map app out, because I bet 4.7% of Americans have heard of Cyprus and 1.3% know where it is. This news story doesn’t matter and will be forgotten. People are having difficulty with the concept that the American economy and financial system have moved on from Europe, are building houses and finding jobs again, and that the major problems for the Eurozone have passed.

As soon as you do a shred of homework on the situation, you realize that a bunch of wealthy Russians are holding large deposits in a tax haven, and the battle is really about who is going to pay the price for the idiots there who over-invested in Greek bonds. Essentially, the country is battling the balance between hitting the banking business (rich Russians who would leave) or ordinary citizens that don’t hide money for sport.

The deal will be probably be amended to lessen the blow on those with smaller deposits, the parliament will approve it, and the world will move on after Cyprus has its 5 minutes of fame, not even 15.

So the VIX futures awoke from their slumber and natural hedging at low prices in SPX options raised the both to reasonable levels. A rise in the VIX of 18% to 13 from 11.3 is not really news worthy, but since most in the media don’t understand the VIX, they will make it seem like news. 13 was a five year low a few weeks back, now it represents a significant shift in fear. Nonsense.

The real game is in futures expiration. Only one day of roll left in the VXX and the April contract will be front and center. Every tick in the front month will move the VXX. It’s actually a good time to hold VXX if you believe that the market is heading lower over the next few days.

Symbol Contract Month Time Last Change Open High Low
VX H3-CF S&P 500 VOLATILITY March2013 16:39:36 13.70 1.13 13.35 14.10 12.93
VX J3-CF S&P 500 VOLATILITY April2013 16:39:36 15.40 0.68 15.25 15.60 14.65
VX K3-CF S&P 500 VOLATILITY May2013 16:39:36 16.35 0.49 16.32 16.60 15.82
VX M3-CF S&P 500 VOLATILITY June2013 16:39:35 16.95 0.28 17.30 17.36

The April contract moved 4.7% higher, and the VXX-IV moved 5.08%, with the couple bps difference owed to the two days of March futures left in the fund that rose in lockstep with the VIX. This is no man’s land for the futures. They are too high to spot VIX, yet not high enough to sell.

Trade/Action:

Still long the VIX and VXX calendars and the April VXX puts, so high, low or flat vol works. Our VIX model shows a modest rise in volatility early this cycle than lower vol later this week into next week. If the futures spike to 17 or so, we will look to add VXX puts.

In the meantime, once our calendar March legs expire, we may sell April calls to shave off even more of our VIX option cost. It will all depend on what happens after Wednesday’s settlement. The weekly put position is going to need a market rally to work. If the VIX April future retraces to 14.4, the VXX will be 20 and we may get out unscathed. This is not a crazy scenario, but probably is about a 30% probability.

Outlook:

We will post our proprietary VIX model chart later this week. Tomorrow housing starts and permits, and the Fed meeting to say nothing but more of the same may put Cyprus in the rear view mirror shortly.

 

 

VIX Falls Again – Futures Trade Setting Up

Posted by Scott Murray on March 8, 2013
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The month is setting up to be a mirror image of the last two. This is what bull markets look like, predictable. Everyone is a hero, because 8 or 9 days out of 10, the market is higher and days of higher prices are strung together. Next week sets up historically as very bullish, and as we pointed out yesterday, the VIX tends to fall next week.

That doesn’t mean it will happen, but we are ready to take advantage of the futures term structure. While we can hope for a down day in the market next week to aid our trade setup, we don’t need that to happen.

The futures held up fairly well today, against a falling VIX:

VX H3-CF S&P 500 VOLATILITY March2013 15:53:02 13.90 -0.30 14.10 14.55 13.85
VX J3-CF S&P 500 VOLATILITY April2013 15:53:02 15.10 -0.15 15.20 15.50 15.00
VX K3-CF S&P 500 VOLATILITY May2013 15:53:04 16.05 -0.05 16.05 16.27 15.88
VX M3-CF S&P 500 VOLATILITY June2013 15:52:59 16.65 -0.05 16.71 16.85 16.53

If you’re holding VIX options and futures right now, you are in prayer mode. You need help, and soon. The VIX fell faster than the futures again today, setting up more pain ahead if the market doesn’t pause. Even if the market pauses, the futures and the VIX can both drop, so the market will need to be jostled to save futures and option holders above 14.

The VIX March puts are still in denial, as they are trading below intrinsic value. If the March VIX settles at its current price, these puts are going to be worth double their price today.

13.00 VIX130320P00013000 0.25 Up 0.10 0.20 0.25 24,844 179,087
14.00 VIX130320P00014000 0.75 Up 0.12 0.70 0.80 35,885 159,991
15.00 VIX130320P00015000 1.50 Up 0.20 1.45 1.55 22,515 214,491

Trade/Action:

Next week we may be putting on a large VIX position, but it will depend on how the first 3 days of the week pan out, in both volatility and futures pricing. Stay tuned.

Still holding April $19 VXX puts. Oddly, these are not living up to their delta right now, and it is fascinating to watch because they become a better value every day. Today the VXX fell .32, and the .21 delta should have been .06 on these options. They only went up .02. This has been the case all week, and it is far too early to cite increasing theta. The roll toll alone hits the VXX by about 8 cents a day, so that negates any theta bleed.

What I’ve noticed is that spread sellers have been selling these while spreading VXX puts. That pushed down their implied volatility. Regardless, with the $20 puts sitting at .97, the $19’s could move significantly if the VXX takes a $1 leg down, which is very possible due to the futures curve in it’s current structure. We will look to add on spikes in vol.

Volatility Arbitrage:

HRB rocketed higher today, and our credit diagonal is going to need HRB to fall a couple percent next week for this trade to work. We have the option of closing the short leg and riding the long leg as well.

@VolatilityWiz

VIX Repeating January and February Pattern – Will the Futures Do the Same?

Posted by Scott Murray on March 7, 2013
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VIX futures fell 3% in the front month and 2% on the back month, as the VIX fell 3.5% today. This pattern of quiet trade is eerily similar to January and February, and if you are holding volatility, you should be worried with expiration dates 6 and 8 trading days away for the options and VIX futures respectively.

With the VIX looking like it may trade below 13 again, here is how the futures reacted:

VX H3-CF S&P 500 VOLATILITY March2013 16:15:00 14.20 -0.50 14.65 14.80 14.15
VX J3-CF S&P 500 VOLATILITY April2013 16:15:00 15.25 -0.30 15.60 15.60 15.20
VX K3-CF S&P 500 VOLATILITY May2013 16:15:00 16.15 -0.20 16.30 16.32 16.05

There certainly no panic in the air here, in more ways than one. The spread between spot and the front month is 10%, and this is unsustainable. The question is whether the VIX will rise or the futures will fall, and that will be played out over the next week or so.

The worst case scenario for VXX holders is if the VIX falls further. The VXX will have enough trouble rolling and holding premium even before it deals with the potential of a lower VIX. Let’s take a look at  March VIX behavior over the OPEX cycle:

March VIX

 

This Pokies chart is using this year’s 19 day OPEX cycle, portraying VIX historical mean and median values. While the VIX is below these numbers today, that should be adjusted for the several years when the VIX was much higher due to market conditions. The pattern appears to show a sharply declining VIX in the last week of the OPEX cycle.

So, the million dollar question is, what will the VIX do over the next 6-8 days? And how will that affect the VXX and VIX derivatives?

Shown at the top, the VIX futures are denying that the VIX will remain at 13. I don’t have a crystal ball, but one thing I can surmise here is that the VXX faces three serious headwinds in the near term. That should be pretty obvious. And a lot of folks would love to collect the VIX insurance payments that everyone made expecting more volatility due to the sequester, and overbought market, etc.

Trade Action:

Long VXX Apr $19 puts

Sitting tight and watching the show next week. If there is a spike, will add around .30.

Volatility Arbitrage Trade:

Sold HRB March $26 calls

Long HRB April $27 calls

Cost – credit of .01

Provided HRB stays below $26 at expiration, the $27 calls are free.

VIX Futures Rise While the VIX is Flat – Mega Trade Setting Up

Posted by Scott Murray on March 6, 2013
Posted in: Uncategorized. Tagged: , , , , , , , .

Quiz time: What can go wrong with the VXX if the VIX stays flat and the futures rise? Ok, let’s step back a minute. What can go wrong with the VXX if the VIX and the futures both remain static?

A lot is the answer to both questions, because the VXX gave away roughly 7 cents in “roll toll” today (I just invented that term), and the spread widened between the VIX spots for both months and the VIX futures. So the futures are sitting on a large premium. One of the two is going to have to give in. The problem for the VXX is that the VIX will have to rise by a significant amount before futures expiration JUST to hold the VXX upright at its current price. Let’s look at how that resolved itself last month:

VXX curve feb13

 

February 12th was the last trading day for VIX futures in February. The entire curve came in by 6-10% at the March and Feb expirations respectively. Now, you can easily formulate speculations as to why this happens, by asking yourself, who would want the VIX to be lower and what would those people have to gain? The VIX can be moved at settlement, by bidding on certain S&P options, but that is a topic for another day.

Anyway, here is how the VXX reacted to this repricing of the futures curve:

VXX feb5-15.jpg

 

So, there may exist an asymmetric risk/reward setup next week, provided the stars stay in this alignment. And, historically there is a good chance that they will. What if the VIX actually fell over the next two weeks? We will go into more detail tomorrow as we unveil some proprietary data on VIX behavior for March.

Trade/Action:

Staying long VXX $19 puts. They got cheaper today and are almost in the buy zone again. They should not have fallen by as much as they did considering the relative price changes in the futures and VXX.

Volatility Arbitrage Trade:

Yesterday’s QIHU trade is working well but is not yet closed. The short strike is essentially zero.

PETM, tweeted out at 3pm today:

March/April call calendar with IV spread at 16%:

Short $65 March call

Long $65 April call

Trade cost- .68

PETM guided lower than analyst estimates, (shocker) and the short strike is toast. The key now is how much profit we can wring out of the long call.