The VIX is at a crossroads – mind the gap.

As you, dear patient reader, have no doubt noticed, volatility is back. The VIX® has reached levels not seen since the peak of the Eurozone crisis over two years ago. The exact reasons might be debatable, but either way October is living up to its perennial reputation as the cruelest month for equities.

VIX

Source: CBOE

Each time in recent history that the VIX closed above 20, it has rapidly collapsed (see above). And duly following the principle of induction, spikes in volatility are now interpreted as a selling opportunity (in respect of the VIX) by the average punter.  One example of this demand: the largest exchange-traded product providing a short exposure to VIX futures has doubled in shares outstanding in the last few days:

XIVSO

Source: Bloomberg, as of Oct 15th 

Yet volatility levels are not guaranteed to fall. If the U.S. Federal Reserve’s largess was indeed the primary cause of the suppressed levels of volatility seen in the first three quarters of this year, the seat-belts are off. QE3 is expected to end in the next few weeks; history was not kind to equity investors in the periods immediately following the last two rounds:

QE3

Source: S&P Dow Jones Indices

It requires an unusual degree of foresight, bravery or foolishness to take short positions in the VIX; there are, notoriously, considerable stings in the tail. Moreover, it is a bet framed in terms of death or glory: the VIX rarely resides in the low 20s, instead historically it is brief staging post on the way to crisis or back to recovery.  And despite the enthusiasm for selling volatility at current levels, losses can escalate very quickly if it continues to spike. At some point, those short investors will capitulate; the risk is then a material short squeeze. 

Hypothetically, such a short squeeze would trigger large purchases in volatility futures just as it is already shooting up. A jump from 25 to 35 in such circumstances is not entirely unfeasible. Investors would be wise to mind the gap. 

Perspective on Recent VIX Action

Since we haven’t had VIX in the mid-20’s for over 2 years it is probably worth getting a little perspective on recent volatility market price action.

The last time VIX was around these levels was early June 2012 when VIX got as high as 26.66.  VIX reached this level after the S&P 500 had dropped about 8.5% in a month.  On May 1, 2012 the S&P 500 closed at 1405.82 and by June 1st the S&P 500 closed as low as 1278.04.  The recent (and all time) closing high for the S&P 500 is 2011.36 from back on September 18th.   We are currently about 7.25% off the all-time high.  Only about 2.75% before the financial press starts frequently using the word correction.  To save you getting out the HP 12C a 10% drop from the high would put the S&P 500 around 1810.

As for the CBOE Volatility Index, looking back to May 1, 2012 VIX closed at 16.60.  Since 2008 was a more recent memory and we had yet to experience the great performance of 2013 VIX was higher and closer to a long term average.  On September 18 of this year VIX closed at 12.03 and we finished today at 24.64.

For the VXX watchers (or critics) from September 18 through today VXX is up just over 45%.  Not so bad for something that no one ever claims to have actually purchased.  Back in 2012, from May 1, 2012 to June 1, 2012 VXX rose about 41% – so VXX has done a little better in this mini-correction.

Finally, let’s get the real story and take a look at the VIX term structure change from Friday to today.  We all know the real VIXophiles don’t do anything without consulting the curve (nor should they).

VIX Curve 10132014

The moves in October and November, which mostly kept pace with cash VIX today, can be read one of two ways.   Either that’s some real panic and more is to come or that’s some real panic and you believe panic is an indication that a market bottom is close.  The one thing to agree on – VIX moving from 12 to the mid-20’s, VXX up 45%, and one of the most defined VIX term structure backwardations in some time all indicate that the dip buyers that have done so well for so long are on the sidelines for the moment.

This Week VXST Index Rose 58.4% and VIX Index Rose 46% – By Matt Moran

This week the CBOE Short-Term Volatility Index rose 58.4%, the CBOE Volatility Index® (VIX®) rose 46%, and the S&P 500 Index fell 3.3%.

More investors are looking to use volatility-based products to diversify and manage risk in their portfolios, as the preliminary estimates for the Oct. 10 (Friday) trading volumes were 1.56 million for S&P 500 (SPX) options, 1.34 million for VIX options, and 515,000 for VIX futures. To learn more about strategies and price trends, please see the graphs below, and visit www.cboe.com/volatility.

Table one week changes Oct 10~

One-week VIX Oct 10

 

VIX Spot Index to Include SPX Weekly Options Beginning Oct. 6 – By Matt Moran

Beginning Monday, October 6, 2014, CBOE will calculate the spot value of the CBOE Volatility Index® (VIX®) using S&P 500® Index (SPX) options with weekly and standard 3rd Friday expirations that more closely bracket the 30-day target timeframe. While this change is not expected to have a dramatic impact on the spot VIX Index (see point 4 below), the change is a more precise enhancement to the VIX as the premier 30-day measure of the expected volatility of the S&P 500 Index.
1. NO IMPACT ON VIX FUTURES AND OPTIONS
The addition of SPX Weeklys options to the VIX Index calculation will not impact the VIX futures and options contracts. The final settlement value for VIX futures and options will continue to use the same VIX Index formula and the opening prices of standard (i.e., third-Friday expiration) SPX option series with 30 days to expiration. Furthermore, the October 6 change will not impact the fair value calculations for VIX futures and options.
2. BACKGROUND AND RATIONALE FOR USE OF NEW INPUTS
Since 2003, the VIX Index has been and will be designed to provide a constant, 30-day measure of the expected volatility of the S&P 500 Index. On most days of the month there is no S&P 500 option that expires in exactly 30 days, and so the VIX Index usually uses the expected volatilities for two different SPX options expirations, and then applies a weighting to develop a constant 30-day measure of expected SPX volatility.
Prior to the October 6 change, the VIX Index used nearby and second nearby SPX standard-expiration (third Friday) options with at least 8 days left to expiration, and then weighted them to yield the VIX (spot) Index. On some dates CBOE needed to do an extrapolation to calculate the VIX Index; for example, on Monday, August 11, 2014, the VIX Index used SPX options that expired on September 19 (39 days out) and on October 17 (67 days out), and then applied an extrapolation to develop a 30-day measure of the expected volatility of the S&P 500 Index.
Beginning on October 6, the VIX Index will use S&P 500 options (including SPXW Weekly options) with more than 23 days and less than 37 days to expiration, and then weight them to yield a constant, 30-day measure of the expected volatility of the S&P 500 Index. The addition of SPX Weeklys options will allow VIX Index spot values to be calculated with S&P 500 Index option series that more precisely match the 30-day target timeframe for expected volatility that the VIX Index is intended to represent.
As shown in the table below, in the calculations on October 6, the VIX Index will use SPXW options expiring 25 and 32 days out, whereas the legacy VIXMO Index will use SPX options expiring 11 and 46 days out.

0-Table with SPX options used
3. VIN & VIF – COMPONENT INDEXES
Two indexes that can help in the understanding of the calculation of the VIX Index, and that track the level of implied volatility from single SPX maturities are: (1) CBOE Near-Term VIX Index (VIN), which reflects the nearer term SPX expiration used in VIX calculation, and (2) the CBOE Far-Term VIX Index (VIF), which reflects the farther term SPX expiration used in VIX calculation. In looking at the 2-month end-of-day chart, one could note that there was a day that the difference between the VIN and VIF indexes was more than two volatility points, and that on each day from August 11 through August 14, the VIX was less than both VIN and VIF. It is expected that after October 6 the spread between VIN and VIF will be tighter, and that the VIX Index value usually will be within the VIN and VIF indexes.

2- VIF VIN VIX

4. COMPARING PAST AND NEW VERSIONS OF VIX
At the VIX website www.cboe.com/VIX, CBOE provides a detailed spreadsheet for “New VIX Intraday Price Comparison – 5/22/14 through 9/16/14.” The spreadsheet contains more than 120,000 “new VIX” values for informational purposes, but please note that the official new VIX values (using SPX Weekly options prices) begin dissemination on October 6. The chart below shows the values in the spreadsheet, and the average values were 12.37 for the new VIX and 12.47 for the VIX Index. The new VIX often was slightly higher than the VIX Index on “extrapolation” dates before the third-Friday expiration of SPX options (e.g., on Monday, August 11), and the VIX Index often was slightly higher than the new VIX around the first of the months.

3- Comparing VIX & New

5. EARLIER (LEGACY) VERSIONS OF VIX INDEX
On October 6 there will be two earlier (legacy) versions of the VIX Index that will continue to be disseminated –

  • Index Introduced in 2003 — CBOE will continue to calculate and disseminate spot VIX Index values calculated using only standard SPX options. Beginning October 6, 2014, the legacy spot VIX Index values will be published under the new name CBOE S&P 500 Standard Monthly Only Volatility Index (ticker VIXMO).
  • Index Introduced in 1993 — The original version of the VIX Index used S&P 100 (OEX) options in its calculation, and is now known and disseminated as the CBOE S&P 100 Volatility Index (VXO).

6. TERM STRUCTURE
Implied volatilities can vary depending on the expiration dates of options, and the concept of term structure can be very helpful in understanding the calculation of the VIX and the pricing of options in general. CBOE provides an updated term structure chart and table at www.cboe.com/vixterm. At that page on Oct. 2nd at 10:13 a.m. Chicago time, the estimated SPX implied volatilities were — 17.35 for the Oct. 18 expiration date, 17.33 for Nov. 22, 17.77 for Dec. 20, and 18.04 for Jan. 15 expiration date. For most of this year the term structure has been upward sloping.

1-VIX Term7. COMPARISONS TO SPX HISTORIC VOLATILITY AND TO VIX FUTURES PRICES
Some investors have inquired about the recent levels of VIX in relation to the long-term average of VIX (around 20) and to VIX futures prices. While some ask if VIX is low in light of worldwide geopolitical tensions, it is worth noting that the VIX Index usually has been higher than SPX historic volatility in recent months (and arguably the VIX Index is not “low” when compared to SPX historic volatility; see chart below). The second chart below shows that in recent months the VIX Index usually has been in contango; the VIX futures often have been higher priced than the spot VIX Index. When asked if investors have an interest in hedging their portfolios, it also is worth noting that the CBOE SKEW Index recently high a 15-year high. www.cboe.com/SKEW.

4-Charts VIX & SPX HV & Fut

8. VOLUME GROWTH FOR S&P 500 WEEKLY OPTIONS
A contributing factor that facilitated the October 6 change is the growth in volume for S&P 500 Weekly options (SPXW), which expire on any Friday of the month other than the third Friday of the month, and are P.M.-settled series. Trading in expiring SPX Weeklys closes at 3:00 p.m. on their expiration date. Average daily volume for S&P 500 Weekly options rose from 65,254 in March 2012 to 272,825 in September 2014.

6 - SPX Weeklys volume

9. MORE INFORMATION
Rising interest in the VIX Index is shown by the fact that this year the average daily volume has grown to more than 188,000 for VIX futures and 640,000 for VIX options.
For more information on the VIX Index and the October 6 change (including links to Circulars, VIX White Paper (with detailed methodology), Press Release, spreadsheets, and charts), please visit www.cboe.com/VIX.

Last Week in VIX – 9/28/2014

VIX was higher on the week, peaking out well over 16 on Thursday before working back down to14.85 to end the week. There were lots of grumblings about VIX being nowhere near the high of the day on the close on Thursday despite the S&P 500 finishing up very near the low of the day. I’ve heard that this could be taken as a signal that the stock market was not expected to follow through on the downside on Friday and that may be true. Also, keep in mind for probably two years whenever VIX moves up, it comes back down fairly quickly. This pattern continues to repeat itself, but much more quickly than it did a few months ago.

VIX PA

 

The VIX term structure remains in contango despite the run up in VIX, although a little flatter than the previous week. In fact the October future closed at 15.80 while spot VIX closed at 15.64. No official backwardation when comparing those two levels despite the scary day for the S&P 500.

VIX Curve

Finally on Thursday there seemed to be several bearish option trades coming into the VIX option arena.   One example was a seller of the VIX Oct 17 Calls at 1.35 who also purchased the VIX Oct 22 Calls for 0.60 and a net credit of 0.75. The payout if held to October expiration (10/22) appears below. Note that settlement under 17.00 results in the credit of 0.75 turning into a profit. Interestingly the last VIX settlement over 17.00 was October 2013 at 17.21.

VIX PO

Last Week in Emerging Market Volatility – 9/28/2014

Both EEM and EWZ were down well over 2% last week as several equity markets gave back 2014 gains. VXEEM was up 2.89 or over 16% in reaction to equity market weakness.

VXEEM PA

VXEWZ, on the other hand was up 6.66% on the week. VXEWZ has been at elevated levels and should remain elevated until national elections are completed next month. These elections can (and are predicted to) go two rounds which may result in uncertainty until the end of October.

VXEWZ PA

The VXEEM curve got pretty flat which I always take as real uncertainty with respect to the next direction for the underlying market. VXEWZ continues to display a shape with no real common term. Basically there is an expectation of a return to lower volatility after the uncertainty of the election is out of the way, hence the much lower November and December futures prices.

VXEEM VXEWZ

Last Week in Gold and Oil Volatility – 9/28/2014

Gold did not break to new multi-year lows last week, but if you read all the news you would think it was just a matter of time. I continue to watch the weekly chart of GLD that appears below and as of this past week the move lower seems to be slowing.

Gold Weekly

 

GVZ moved up just under a point with that move mostly a result of the price action in the equity market on Thursday. Without that cross market push higher in GVZ it probably would have been a fairly slow week.

GVZ PA

Expected volatility for the oil market was also pretty tame on a week over week basis. It may just be that the US becoming a bit less depending on foreign energy sources is resulting in a new paradigm for oil traders. This may be good for the majority of us, but it has some oil traders pulling their hair out waiting for the next big move to capitalize on.

OVX

Sticking with the Gold theme above, the inversion of the curve this past week makes me pause and wonder if the markets are expecting GLD to hold around current levels.

GVZ OVX

Last Week in VXST – 9/28/2014

Thursday VXST was up as much as 38% intraday before settling the day up ‘only’ 23%. I am well aware of the Monday morning quarterbacking here, but seeing VXST come back in like that despite the S&P 500 closing near the low of the day Thursday may have given traders confidence that the sell off Thursday was not going to follow through on Friday.

VXST PA

 

The curve finished the week pretty flat which indicates uncertainty. The stock market bears won the tug of war on Thursday and the bulls were the winners on Friday. Looking at the Oct 1st VXST future in line with VXST makes me think there is a lot of wait and see going on for next week.

VXST Curve

I checked through the VXST option trading activity last week and came across what appears to be an unfortunate seller of volatility. We are all aware of the S&P 500 sell off on Thursday that resulted in VXST running up to 17.85 before finishing the day at 15.94. On Wednesday it appeared a trader expected a week of quiet activity and sold some slightly out of the money calls.

Wednesday in the afternoon someone came in and sold a little over 200 of the VXST Oct 1st 17 Calls taking in 0.15. VXST finished the day on Wednesday at 12.69 and the Oct 1st VXST future closed at 13.40. On Thursday VXST ran up as high as 17.85 which places those options 0.85 in the money – of course VXST options pricing is based on the corresponding future and the VXST Oct 1st contract ‘only’ ran up to 16.90 on Thursday. Either way, this is still a pretty painful trading experience. For a visual of what this trade lived through on Thursday see the payoff diagram below –

VXST PO

If you are still getting up to speed on the relatively new VXST make sure to visit www.cboe.com/vxst or drop me an email with questions at rhoads@cboe.com.

Last Week in Russell 2000 and Nasdaq-100 Volatility – 9/28/2014

I flipped a coin and decided to start with the Russell 2000 (RUT) volatility action last week. I was 50 – 50 on what to begin with as I found both RVX and VXN price action equally of interest last week, but not for the same reasons.   The poor RUT lost 2.41% last week which puts the small cap index down 3.81% for 2014. Also this year RVX has been elevated relative to recent history and the two other tradable broad based volatility indexes (VXN and VIX). The 12% gain in RVX last week was actually much less than the move higher in VIX and VXN.   As mentioned RVX is at elevated levels to the VIX and VXN so there a higher base when determining the price move. However, RVX rose 2.15 points while VIX was up 2.74 and VXN moved up 3.05 points. Remember implied volatility is an anticipatory measure and the higher level of RVX can be taken as an indication that RUT will drop more than the S&P 500 or Nadaq-100 (NDX) if there is any weakness in the US markets.

RVX PA

 

VXN was over 22% higher. As mentioned above VXN rose more on an absolute basis than VIX or RVX last week. In addition to the move lower in the underlying market (NDX) VXN is also displaying a bit of anticipation (or worry) in front of 3rd quarter earnings which kicks off in just over a week.

VXN PA

The two curves are slightly different and I’m going to play the earnings card here as well. The flatter VXN curve may be showing an expectation of lower levels in time as earnings season passes. The steeper RVX curve tells me that the market still thinks there is more risk in small cap than large cap stocks.

VXN RVX Curves

Last Week in Volatility Indexes and ETPs – 9/28/2014

This is one of those weekends where I get to add a 3rd curve into the mix below. Thursday, as all of us that were not under a rock know, was a hectic day for the equity market. Hectic days in the stock market result in green days for volatility. The purple line below shows the closing VXST – VIX – VXV – VXMT curve on Thursday as well as the week over week curves. Note the change from Thursday to Friday was a pretty orderly one, but also note that VXST remained at a slight premium to VIX. Two thoughts on that premium – 1) traders are still concerned we aren’t out of the weeds quite yet or 2) VXST remained high as this coming Friday is the employment report.

VXST VIX VXV VXMT Curve

 

The long exchange traded products did what they were designed to do this past week, giving holders nice returns. VXX was up almost 8% which is pretty impressive considering the October futures have over two more weeks until expiration. Of course the short ETPs were both lower, down over 8%. One other week over week change that stands out is the VVIX which finished the week over 90 after getting darn close to 100 on Thursday. This is a measure applying the VIX methodology to VIX options which tends to move higher when there is big demand for VIX calls.

ETN - Indexes

Finally, I came across a pretty interesting trade and profitable trade from Thursday. As we were falling apart and SVXY was trading at 77.46 someone came in and sold some of the SVXY Sep 26th 80 Puts at 3.20. This trade is not a suggestion, recommendation, or for the faint of heart. In this case, the seller benefitted as the stock market firmed up on Friday SVXY climbed higher and finished at 79.90. So an SVXY put that could be sold for 3.20 with just over 24 hours until the settlement price was locked in finished 0.10 in the money.

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