Instead of posting here, I put up an article on Seeking Alpha today:
http://seekingalpha.com/article/2226103-will-vix-expiration-bring-any-surprises
Instead of posting here, I put up an article on Seeking Alpha today:
http://seekingalpha.com/article/2226103-will-vix-expiration-bring-any-surprises
I want to thank all the subscribers that have signed up for the newsletter and trade alerts. All of the trades in Tuesday’s installment are working, and I hope you have taken advantage of the trade alerts as well.
Even I expected a larger move in the VIX today when the S&P was down 25 points, but here is why it didn’t:
These are the stats for the SPY options today. When the SPY was getting nailed, folks SOLD puts and bought calls. More puts were sold than bought and more calls were bought than sold. That is a recipe for a lower VIX, without a doubt. This implies that no one believes that the S&P 500 can actually fall more than a certain amount before dip buyers will arrive. And you can’t blame them, that intraday buy-the-dip trade has seen it’s share of stick saves of late, which are often accompanied by a gap up the next day. When someone else has your back, why worry about selling the tiniest of volatility premium when it shows up?
But when something gets too easy in the markets, eventually it gets taken away or at least burns a bunch of folks to teach them a lesson. Selling puts like this can be hazardous to your health, maybe not today or tomorrow, but it will catch up to you eventually.
I highlighted in the newsletter that the SPY was technically setting up for a down move, and today it arrived. What happens when there is very little volatility in the options and the index makes a 1% move? This:
This doesn’t even tell the whole story frankly. If you timed a near-the-money SPY put right today, you could easily have made 400%, instead of the 225% seen at the close. Here is a 5 minute chart of the weekly 187 SPY put:
Actually, if you bought it at the open, you could have made 500%. That is what happens when there is no juice in the options. So, while the market is underpricing volatility, that doesn’t mean that you can’t own it in other ways, and this is a prime example. This is a long vol trade without using VXX or VIX.
We may have more trade and volatility email alerts tomorrow, if you are interested, the newsletter link is in the above menu.
You would think, and I apparently am the only one with this thought, that the convergence of a declining 10 day moving average with a rapidly approaching 50 day would get some folks prepared for a possible downside moving in equities. Not so. The implied volatility in S&P puts is incredibly low:
Look at the implied volatility on the puts, if this doesn’t amaze you, I don’t know what to say. The S&P 500 falls 20 points from the high of the day, and what did people do? They SOLD puts. They have become so brazen, that they aren’t buying them, they are sellers. Look at the call side, the implied vol going out weeks is higher on the CALL side. All this happened on this kind of price action:
The energy sector has been a leader lately, and look what it did today:
The saving grace for the market today, was the financial sector. The recent leaders, utilities and energy reversed, and higher yields helped out the banks:
But if folks expect the financials to carry the baton from here, the bounce ran out of steam as the 50 rejected the XLF after two strong days:
The recipe is there for a rude awakening. Will it happen? The crowd has voted emphatically that the answer is no.
I added to May 30th VXX $38 calls today.
(I will be starting a volatility newsletter shortly for $25/mo. It will include my perspective on the volatility indexes, trading ideas, VXX analysis, and volatility forecasting using proprietary models. Real-time email trade alerts and volatility email updates will be included. The sample will be available by the end of the week and it will go out on Tuesday nights. Email me at scottmurray1 (at) gmail.com if you are interested.)
I mentioned a few days ago that May can be very kind to investors, and we looked at last year’s chart of May as an example. There are still a ton of earnings releases, and bull markets do not just turn around and fall. They fight to hang on, because the trend is still up. Today the S&P tested the 50 day moving average and held convincingly:
The SPY was able to reclaim the 10 day moving average as well. We are nearing some kind of inflection point it appears, as the 10 day and the 50 are near a cross. If you see the 10 cross through the 50, get ready for the knuckleheads on CNBC to be trotted out with their “death cross” prognostications.
The Nasdaq and Russell 2k look sickly, and the Rut2k barely recaptured the 200 day moving average. That is a big one.
Meanwhile, while under the surface, there are clear rumblings of something brewing, the VIX futures are a mere 20 cents from their lowest point since January:
As you can see, prices at these levels don’t hang around forever. This is the time to prepare, however you see fit. I will be watching closely, and if I can sell some UVXY and VXX spreads a few weeks out or purchase some in the money calls in VXX at prices anywhere near a VIX future of 14 then I will be doing so. I will go out to May 30 or even June. Most folks just wait for volatility to arrive before doing something; it is my preference to be a little bit early rather than late. Friday might be the day to put on some positions, as we are nearing a 8/34 cross on the 30 minute chart, and that can support a bullish market  for hours/days ahead if it can get there. A bullish day tomorrow and I will be on the sideline, being patient.
As you probably know, I almost never buy VXX calls, but this set-up is fairly rare and is occurring with seasonal difficulties, earnings ending, and divergences showing up in many areas. Patience is warranted though, you are probably not going to wake up one day and see the market down 25 S&Ps.
I do already own some VXX May 30th $38 calls and am short some UVXY May 16th $48-47 put credit spreads.
(I will be starting a volatility newsletter shortly for $25/mo. It will include my perspective on the volatility indexes, trading ideas, VXX analysis, and volatility forecasting using proprietary models. Real-time email trade alerts and volatility email updates will be included. The sample will be available by the end of the week and it will go out on Tuesday nights. Email me at scottmurray1 (at) gmail.com if you are interested.)
You really can’t ask for much more in VXX. So often the VIX futures sit in a range where they are untradeable, usually when the VIX is in the 14-16 area. In those cases, getting long volatility could eat you alive, yet getting short could get you killed. This is not one of those times.
Let’s start with a chart of the front month VIX future this year:
There is a flow to these spikes, no? Granted this is only 2014 right here. But go back to last year and the year before that and you will find that this rhythm persisted then too. I don’t ever look at volatility like folks out there on CNBC and stocktwits, trying to get ready for the next crash, that is wasting precious time and money when you can take what the VIX gives you over and over again. Sure, if there is a crash, I’ll be happy to ride that too, but realistically, we deal with the market we have, not the one that we may want.
So every 3-6 weeks, you get some sort of rumble, and this is normal and healthy in bull markets. And now that the “sell in May” headlines are fading, it is time to look toward the next rumble. People are feeling better, their tech stocks have stopped cratering, and May is off to a quiet start. Let’s look at how last May went, just for fun:
May 3rd featured a better than expected jobs number, and off it went. The last green bar was on options expiration last May and then things got wild. There are correlations to volatility and the option expiration cycle, and there are correlations to volatility and seasonality. I will go into these frequently in the newsletter.
Today I added a few VXX May 30th $38 calls for 2.35. Tomorrow is the day that I was targeting to add more considering the performance of Tuesday in the markets this year. It has been an automatic ramp on Tuesdays, so it may offer some nice prices to get long vol.
(I will be starting a volatility forecasting and signal service shortly for $25/mo if you are interested, and that will also include an email service with real-time trades, and a weekly newsletter breaking down the volatility landscape. There will also be sections with basic option trades and education, ETF analysis for straight trades on volatility, inverse and leveraged funds, and profit loss diagrams. Imagine what you see here and a lot more. Email me at scottmurray1 (at) gmail.com if you are interested.)
In part one, we looked at the ranges of different sector VIXs, compared the S&P VIX to a similar past time-frame during a mid-term election cycle, examined the current VIX futures contango structure, and did some rough calculations of negative roll yield in the current structure. Now we want to examine some trade set-ups to take advantage of a low volatility environment.
I want to demonstrate three trade scenarios:
-Put spread sales on VXX and UVXY
-Long VXX calls
-Long VXX diagonal spreads
The main premise of these set-ups is two-fold: A. That volatility can go higher in the next month or two due to seasonal factors, and because volatility is at the low end of the range, thus risk is under-priced. B. That these trades can be set up with an asymmetric risk/reward scenario; that the risk of loss is far less than the potential for gain.
Let’s make a projection of VXX option prices using the negative roll formula:
So if you believe the VIX structure will remain in this format, here are some projections for VXX and UVXY prices at future points in time taking into account the negative roll yield. In 5 trading days the VXX will be roughly 39.52, in 10 days 39.03, etc. The UVXY decays twice as fast, relative to its current price.
VXX Put Spreads:
Here is the VXX option chain:
One put spread example would be to sell VXX put spreads for next week or the week after at a level that would take into account the negative roll, and gives you some wiggle room for a shift down in the VIX futures of 1 or 2 percent more. For the May 23rd expiration (May5), the VXX 38-37 put spread can be sold for roughly a .25 credit, whereas 15 days of negative roll only get you to $38.55. If the futures curve fell around 2%, that would equate to a VXX price of roughly the $38.55 less another 2% or 37.75.
Thus, it would take not only a significant drop in vol from here for this trade to lose , but there could be no hiccup in the market during this period. If the S&P saw any selling, the VXX simply cannot get to this price. The odds are that you will keep the premium. This same method can be applied to UVXY, at say the $50-48 levels.
VXX Calls:
In the above case, your profit is capped at .25, but it you are bullish on volatility or bearish on the market, it is not a bad time to get long vol using VXX calls. As we described above, there is only so far for the VXX to fall considering how low the futures are, so you can choose some calls that don’t put the entire cost of the calls at risk yet give you a ton of upside if the market sees increasing volatility or sells off:
Again, knowing that the VXX will have a tough time falling below $38 in 20 trading days, you could purchase the May 30th VXX $37 calls for $3.35 debit. At risk over the next two weeks is realistically around $1.50 of that $3.35, but if the market sells off between now and May 30, the upside could be 100-300% of your real risk of only $1.50 per contract. It would be up to you in two weeks to reevaluate how you see the next two weeks after that playing out, and adjust accordingly, if you hadn’t sold them by that point.
VXX Diagonal Spreads:
This is about as beautiful as option trades get, because you not only take advantage of rapidly decaying premium out-of-the-money, but use that to defray some of the cost of a long volatility position:
If you suppose that this week will be a quiet one, but there are storm clouds on the horizon, you could sell the May 9th $41 call for .45 Â or the $41.5 call for .35 and buy the May 23rd $38 call for around $2.50. Now you are long volatility for no premium paid, essentially $2 which is the current VXX price, less the strike price of the long call, $38. Another advantage of this trade is that you can sell against it again at the end of this week to further cut into your cost of the long call. Also, if volatility rises between now and Friday, diagonal spreads benefit by rising volatility or vega.
So there are three ways to get long vol without paying high premium in VXX or VIX calls. The odds are with you on these trades, whereas buying out-of-the-money calls on the VIX and VXX as many people do is a consistent losing strategy.
I will be starting a volatility forecasting and signal service shortly for $25/mo if you are interested, and that will also include an email service with real-time trades, and a weekly newsletter breaking down the volatility landscape. There will also be sections with basic option trades and education, ETF analysis for straight trades on volatility, inverse and leveraged funds, and profit loss diagrams. Imagine what you see here and a lot more. Email me at scottmurray1 (at) gmail.com if you are interested.
This has been an interesting year in volatility. The past few years have rewarded the most simple of vol strategies, selling vol into U.S. political events and over-hyped European debt crises. (See Cyprus, Portugal, Greece. Greece just came to the bond market last week, and it was SEVEN times oversubscribed at a yield of 4.95%. Apparently their “junk” rating is junk:Â http://www.bloomberg.com/news/2014-04-22/samaras-sees-greek-bond-yields-falling-more.html)
But now, just as then, a simple strategy can be almost as profitable as long as you exercise patience and know your math in the volatility ETN’s.
Volatility that remains in a firm low range for long periods is not rare, although folks on television frequently harp about the VIX being broken. But let’s be frank, a lot of the CNBC folks do almost zero homework and regurgitate what they hear among each other as fact. The Russell 2k VIX (RVX) and the Nasdaq VIX (VXN) both exceeded 20 recently, a fact you would never hear on CNBC. That is where the volatility was, and the implied volatilities of those indexes reflected that risk.
Russell 2k, Nasdaq 100, and S&P 500 VIXs:
Unfortunately for vol traders/hedgers, Nasdaq VIX and Russell 2000 VIX options were a flop. That also appears to be the case with the VXST, the short-term S&P 500 VIX options. There has yet to be any significant volume in that recently released product. Fact is there are plenty of weekly options available these days in the ETF world for hedging/trading. But, the CBOE does a terrible job of educating anyone in the media about how the VIX works, and therefore no interest or knowledge flows into what could be very useful option products in the VXN and RVX. Especially this year, as you can see in the above charts that the Nasdaq and Russell indexes have entered higher vol ranges.
Anyway, back to plain old S&P VIX, let’s look at a period of time when the VIX held a similar tight range below 18:
Jan 2004 to June 2006:
And 2012 to today:
These are weekly VIX charts covering the same length of time. Not only that, these two charts cover the same time in the presidential cycle, ending in the mid-term election year. They are incredibly similar. In 2004-6, the internet bubble was fading into the distance, and here we are trying to forget about the mortgage crisis.
So vol never goes away, but it hibernates for weeks just to reappear again, albeit in a lower range. So if you have weeks of VIX in the 12-14 range, what can you do? Sell VXX and UVXY put spreads.
First you need to calculate the negative roll in the futures term structure. Here at vixcentral.com, he does it for you:
Courtesy vixcentral.com
So in the VXX’s case, the calculation is roughly:
.0638 (contango given in the above chart) / 25 (days in this vix roll cycle) x $40 (VXX price) = 10 cents per day of negative roll. This is what the VXX loses on a daily basis at this current structure while rolling from May to June on a daily basis. Now you know what you can roughly expect the VXX to lose over time provided this structure persists. It allows you to project how far the VXX could fall.
Now you need to know how much the VXX is holding of each future, May and June:
Almost 50% of each. This is important because the more expensive June future will not rise or fall as fast as the front month. So, if the VXX is heavily back-loaded or front-loaded with a majority of one option, it is far more susceptible to big moves up or down. So right now, it is sort of sluggish, it does not want to move at the same speed as spot VIX. You need to know this, because generally this product moves quickest at the beginning and end of VIX cycles.
Ok, we’ve laid the groundwork for the trades. Next post this weekend I will show some option chains and build some trade structures.
With the market finally showing some weakness after an unrelenting move higher over the last six weeks, the VIX has come off the 13 handle to almost 18. None of this is out of the ordinary, although the financial media acts like the world is falling every time the market takes any kind of a break. There always must be an explanation for a down day, and if they didn’t have Crimea or China to fall back on, they would find some rumor or bring out the bearish punditry to babble about fiat currencies or 1929 chart similarities. There is more BS and misinformation on CNBC than anywhere else unless you watch Fox News.
These pullbacks are opportunities to sell some vol, and there are plenty of ways to do that. First, the VIX curve provided buy vixcentral.com:
You can see the backwardation in the front of the curve and how the entire curve shifted higher over the past week. The VIX March future expires next week, so it will be in lockstep with the VIX at this point. The implied vol on the VIX options expiring Tuesday is through the roof:
If you think things will not escalate in the next two days, or that there was a risk premium in the Crimean vote, then you can sell VIX call spreads that expire Tuesday and settle Wednesday morning. 19-21 would net around .25, and 18-20 would net around .50.
Another way to sell vol without having to look at you computer every 5 seconds, would be to sell VXX spreads out to March 28th or later. It is holding virtually all April futures right now, and that will be the front month come Wednesday morning. Here is the chain for March 28th, which is a bit off due to the weekend quoting being less than accurate:
The 48-49 spread can be sold for about .30, and you have two weeks for things to calm down only slightly. If the market sells off to 1800 or below, than you can expect the VIX to approach 20 and the VXX can certainly rise 10-15%, sending the VXX to the 52 area. But even that will not last for very long as the faster the market falls, the faster it gets to real support. (Permabears can ignore that sentence, since we all know you think the SPX is going to 1000.) The key will be to roll this spread out before it’s too late and it widens. But if the VXX were to head to 52, I would be selling April 4 or 11 spreads over 55.
Other options of selling vol include selling put spreads on the ETF’s with elevated vol like IWM, FAS and TNA. You can get almost .50 for an 86/84 Mar 28th FAS put spread. You can also sell SPY put diagonals, taking advantage of heightened vol in the nearer options.
On April 10th, the VXST, or short-term 9-day rolling VIX based on SPX option volatility will give vol traders the ability to trade short term vol in an more efficient way than trading the monthly VIX options. I will discuss that more as we get closer to that date.
There hasn’t been much volatility to speak of, but that could change, especially as we get closer to May and June. As the market’s best season (November-April) is nearing an end, I decided to get back to posting once or twice a week, and more frequently if we experience higher vol levels. There really hasn’t been much to write about this year, frankly, without any political nonsense, taper panic, or Eurozone defaults. Kind of boring, right?
Today I want to go over the VXX structure again, since I endlessly see tweets from folks that are completely baffled by why the VXX doesn’t rise when the VIX rises or the market falls. These events are not mutually inclusive. The VIX can fall in a falling market, and frequently does after market events, like a highly feared/anticipated Fed meeting. Let’s look at the current VXX structure again for starters:
After today, the VXX can only hold 25% of March futures, because it is only being traded for 5 more days. The VXX Pokies rolls every day. So the driver of the VXX is now the April future. Here is what the futures curve looks like:
The April VIX future barely moved today as you can see here:
So there you have it. The April future moved up a measly 1%, and so did the VXX. Now, if the market really cared about the sell-off today, the VIX would have broken 15 to the upside. Without any conviction from those buying S&P puts (the basis for the VIX calculation), then the futures market is not going to take notice, and still has a considerable buffer of 1.2 built in: VIX future of 16.05 less VIX of 14.80. There is no fear or protection being demanded at the moment.
From an options perspective, there isn’t much to do in the VXX or UVXY. The future being 16 is too low to sell VXX calls and too high to sell VXX puts. We will sit and wait for a spike or a dip to get busy.
There has been no volatility to speak of lately, so the posts here have been thin. While my focus therefore has been on specific name volatility arbitrage, (calendar IV spreads) there are hints that volatility may rise in the month ahead. Let’s examine why.
First let’s look at the S&P, NDX, and RUT charts (using SPY, QQQ, and IWM for volume profiling):
All three charts are very bearish, with MACDs rolling or crossing on every one. As you can see, MACD does not immediately turn around and head back higher until it resolves itself. It almost always leads to lower prices. Because uptrends do not reverse on a dime generally, (blow-offs aside) you get some chop at the top. That is what we are doing right now. But the canary in the coal mine may be the Russell 2000. It’s already only 2% above the 50 day after giving up 3% this week alone. Unlike the other indexes, it does not respect the 50 MA that much, unlike the S&P 500, which everyone watches like a hawk when it nears the 50.
The VIX during this chop is still dormant. While the media tone has slightly changed from “QE forever” to “QE taper in Jan, maybe”, folks are still not bidding up put options. They have reason to be complacent, November is a great month for stocks historically, #3, and when followed by great Seps and Octs, the chase usually is on to Dec 31st. But you more need buying, and there has been a ton of inflow lately to equity markets. The VIX may be lurking though, for at least an uptick:
When the VIX sits down here, it takes 4-6 weeks generally for it to make an inevitable move higher. At least a move off of the 12-13 level. The good thing about the VIX being so low, is that you don’t have to pay much if you like downside options, anticipating a natural consolidation in stocks. One thing that works pretty well in this scenario are diagonal spreads. Let’s look at one example of how to get your risk/reward in asymmetrical shape.
This is the option ladder via the fantastic LiveVol platform. I like diagonal calendar spreads in this scenario. You would sell a nearer term put at one strike and buy another longer dated put at a lower strike, thereby lowering your cost and giving you the opportunity to make multiples on a market slide. One potential trade would be to sell the SPY $174 Nov 8 put for .40 cents and buy the Nov 15 $173 put for .56, for a net debit of .16. If the SPY stays flat or falls over the next two weeks, this trade will work and could be a big winner.
A rise in volatility will also juice the longer dated put as well. It is very hard to lose significantly on this trade. If the market stays right here next week, without even falling this trade will probably make 50%. If it falls to 174 next Friday, then you are looking at a 5x or more return, as the ATM puts for next week are worth around $1. That is without adding any vega to the put value.
Expect more posts in the coming week with vol trade set-ups.