Last Week in Emerging Market Volatility – 11/16/2014

The iShares MSCI Emerging Markets ETF (EEM) was up about a half percent last week despite the performance of the Brazilian market. We shall get to Brazil in a moment. EEM is down down 0.03 for the year for a loss of 0.07% which is close enough to say flat on the year. The result of the relatively quiet week for EEM was a quiet week for VXEEM which managed to drop 0.20 or about 1% to finish the week at 18.55.

VXEEM PA

The Brazilian market continues to be an adventure. For a couple of months it was all about the national election, not it is about the future of the Brazilian economy which appears shaky. The result of uncertainty is always higher implied volatility and that’s where VXEWZ is – high.

VXEWZ PA

The curves tell two different stories as well. VXEEM depicts sanity and smooth sailing ahead. VXEWZ, continues to be in backwardation which means uncertainty about what is next for Brazilian stock prices continues to prevail.

VXEEM VXEWZ

Last Week in Gold and Oil Volatility – 11/16/2014

Friday was a pretty slow day on the floor at CBOE. I hosted groups from a couple of different colleges mid-day on Friday and there were very few large open outcry trades coming into the SPX or VIX pit while we were on the trading floor. Apparently all the Friday action was in the gold market. GLD finished the week up 1.3% with most of that move coming on Friday. What also resulted from that move in gold was a spike in the CBOE Gold ETF Volatility Index (GVZ) which rose 11.3% on Friday alone. The implied volatility of commodity markets is always unique to the underlying market, but generally it will move up based on a rally or a big drop in the underlying market. GVZ has demonstrated just that over the past few weeks as gold and broken support and then put in a small rally.

GVZ PA

The oil market continues to be in free fall with USO having dropped seven consecutive weeks. This persistent downtrend, with no support in sight, has resulted in the implied volatility of options on USO indicating elevated risk. In layman’s terms, that means the market expects continued excessive price moves, either through a quick short covering rebound or prices continuing to drop. The direction of the outlook doesn’t necessarily impact OVX, just the potential magnitude. The level of OVX remains over 30.00 which may indicate that some large price swings are being anticipated by the market.

USO Weekly Chart

Both curves are in well-defined backwardation which just reinforces the views from above. As long as these shapes persist expect headlines decrying new lows in gold or oil or a quick rebound from the recent downtrends.

GVZ OVX Curve

Last Week in Russell 2000 and Nasdaq-100 Volatility – 11/16/2014

The Russell 2000 was up a whopping 0.04% last week which lagged the gains racked up last week in the S&P 500 (0.39%) and Nasdaq-100 (1.55%). Despite the underlying market rising more, VXN was actually up slightly more than RVX last week. The Russell 2000 has had a tough 2014, but since the equity market bottomed out on October 15th small cap stocks have kept pace with large cap stocks as represented by the S&P 500.

Both the RVX and VXN curves experienced unusual moves as the spot indexes rose and the futures all lost value. November expiration is this coming Wednesday so with little action in the index, the futures closed the gap by losing value.

RVX VXN

Last Week in Short-Term Volatility – 11/16/2014

I’m very hung up on volatility indexes not approaching 2014 lows despite the S&P 500 making new highs. This may be attributed to the rough patch the equity market encountered back in October or a lack of safety net that resulted from the ending of Quantitative Easing. Either way, note the chart below that depicts the VXST closing prices for each of the 41 times in 2014 that the S&P 500 closed at a record high.

VXST SPX Highs

The average VXST close on S&P 500 record days is just over 11. All the recent closing levels for VXST have been above the average for 2014 and well above several closing prices for VXST this year.

I checked in on VXST option trading this past week and the open interest in some contracts caught my eye. All four of the active expiration dates have traders looking to VXST options for some sort of short term volatility exposure. The table below shows the top 10 VXST option contracts with open interest.

VXST OI

Finally, the curve shifted higher last week, reflecting high risk expectations among option traders as we reach the end of 2014. It may be actual worry about a drop in the market or an increased desire among managers to lock in gains for the year.

VXST Curve

Last Week in Volatility Indexes and ETPs – 11/16/2014

The S&P 500 set three record highs last week, you may not be aware since there was not very much fanfare surrounding record closing high numbers 39, 40, and 41 for 2014. Also, Friday’s record was almost a rounding error to the upside relative to Tuesday’s record. Sticking with a theme I latched onto last week the VXST – VIX – VXV – VXMT term structure curve below has an extra line on the bottom. The purple line shows the average closing 2014 term structure on days where a record high was set for the S&P 500. The other two lines show the same term structure for the past two Fridays, both of which were record setting days. I’ll just note what I pointed out a week ago, risk perceptions are high considering the S&P 500 is at all-time highs.

Term Structure Curve

Even though VIX moved higher last week the long oriented exchange traded products was a victim of the November and December VIX futures contracts drifting lower. Note that November VIX expiration is this week so VXX and all the other long ETPs will be comprised of December and January 2015 VIX futures this time next week.

ETPs Indexes

In the ETP space, there was a trade that will benefit if low VIX is the norm through Boxing Day (the day after Christmas). Someone came in and purchased almost 10,000 of the VXX Dec 26th 24 Puts for 0.17. In order to hit break even, 23.83, VXX needs to drop 16.71% in 28 trading days. That sounds like a lot, but VXX grinds lower in low volatility environments. Armed with those statistics and price history for VXX and the index VXX is designed to replicate I went to work. Using data going back to late 2005 I found that over 2207 rolling 28 day periods VXX dropped over 16.71% 620 times or just over 28% of those periods. Those numbers put a little different perspective on the payoff diagram below.

VXX Payoff

Last Week in VIX – 11/9/2014

This weekend I felt like Ed Rooney. Not Ed Rooney after Ferris Bueller’s sister kicks him in the face 12 times, Ed Rooney when he kept repeating nine times to Ferris’s mom, however my number was 38. I decided to take a look at what the volatility markets did each day the S&P 500 made a new high in 2014. I was genuinely surprised to see 38 record highs for the S&P 500 this year.

I then took a look at VXST, VIX, and the term structure as created when using the VXST – VIX – VXV – VXMT closing curve.   Two previous blogs from this weekend talk about VXST and the curve. In this space I take a look at VIX which has an average closing level of 12.15 when the S&P 500 makes a new high, Friday VIX closed at 13.12 or almost a point above that average.   All the closing VIX prices for each day when the S&P 500 set a record appear in the graph below.

VIX on Record Days

What is significant is how the premiums are higher despite our most recent rebound to new highs. It could be a function of the most recent market set back being more dramatic or it could be an indication that the market is more nervous when looking forward.   The lack of QE around as a safety net could be a contributor as well.

Looking at the futures market I see a bit more nervousness as well. November at a premium of 1.68 is a bit more than the normal front month premium in 2014. It just could be the carry traders have decided to call it a year or be a little more cautions as the year comes to an end.

VIX Curve

Last Week in Russell 2000 and Nasdaq-100 Volatility – 11/9/2014

I’m going to start with the Nasdaq-100 because I have a lot more to say about Russell 2000 volatility this week. VXN was down about 6% despite the underlying market rising only a little last week. This is one of those time periods where VXN and RVX both appear to take the lead from VIX more than in reaction to what may be going on in the underlying market.

NDX PA

Every weekend there is something that always gets me a bit excited when reviewing what has been going on in the world of volatility. This week the price action in RVX is really getting my attention. Despite RUT losing a little ground on the week RVX was down 6%. Everyone that watches the markets knows 2014 has been a tough year for the Russell 2000 and the small cap sector. In the volatility space this has shown up with RVX being at a bigger premium relative to VIX than has been the norm in past years.   The chart below shows a ratio created by dividing the closing price for RVX by VIX each day in 2014.

RVX VIX FIXED

My initial intent behind putting up this chart was just to show that RVX is just below the average normal premium for 2014 (1.40 shown in purple above) and note that this may be the option market signaling less concern about small caps relative to large cap stocks. What also caught my attention was the closing ratio on October 15th.  It is rare that RVX closes lower than VIX and to be totally honest – I missed this until today.

The next move was to see what the S&P 500 and Russell 2000 have done since October 15th. I was honestly surprised to see the Russell 2000 is up 9.41% while the S&P 500 is up 9.10%, especially since RUT was down last week.  I expected RUT to be higher, but not to a greater extent than the S&P 500.

There are two takeaways from all of this – (1) the option market correctly signaled lower risk in small caps and (2) relative to the recent history the option market price action is showing less concern about the Russell 2000 relative to the S&P 500.

Finishing up and taking a look at futures markets a couple of things stand out. VXN is in a state of complacent looking contango.   RVX is in pretty steep contango which is normal, but when the curve is this steep you question the risk being discounted by the futures pricing. In plain speak, despite the talk above about RVX showing less risk for small cap stocks relative to large cap stocks, the futures pricing indicates a bit of continued nervousness.

VXN RVX

Last Week in Emerging Market Volatility – 11/9/2014

Emerging markets had a tough week relative to stocks in the US.  EEM was down 2.2% which places the fund down for 2014.  Brazil was a little worse off with the EWZ dropping over 5% which places that market down about 6 1/2 % for the year.  The numbers for EWZ are even more amazing when you consider than it was up over 23% at the peak this year.

With the markets under pressure you would expect the volatility of options on those markets to have worked higher on the week.  That turns out to be a half-truth as VXEEM was down slightly for the week while VXEWZ was up 4.5%.  The price charts for both appear side by side with VXEEM on the left and VXEWZ on the right below.

VXEEM VXEWZ PA

The curves also tell very different stories.  Contango persists for VXEEM while backwardation remains in place for VXEWZ.  The move higher in the November VXEWZ contract was pretty startling as the futures markets were anticipating a quick move lower in VXEWZ that does not appear to be materializing.

VXEEM VXEWZ

Last Week in Gold and Oil Volatility – 11/9/2014

Gold implied volatility in the form of the CBOE Gold ETF Volatility Index (GVZ) was down slightly on the week despite GLD not appearing to have developed a new support level.  Despite dropping, GVZ at 21.38 is definitely elevated relative to this year’s average of 15.85 and is just a couple points lower than the 2014 high.  Note the chart below showing weekly price action for GLD and the significant support level that was violated just a couple of weeks ago.

GLD Weekly

The oil market continues to languish at lower levels and OVX remains at relatively high levels.   I spent a good part of the week last week traveling around Texas and I can tell you that there is some real concern among investors that energy prices may continue to move lower.  OVX close to 30 is a good quantification of those concerns.

OVX PA

Taking a look at the curves, GVZ in more backwardation than the OVX term structure can be taken as an indication that the market expects support for gold prices before support or stabilization of oil prices.

GVZ OVX

Last Week in Short Term Volatility – 11/9/2014

The S&P 500 closed on Friday at an all-time high.  For those keeping score this is the 38th record for the S&P 500 in 2014.  I replaced the daily price chart that normally appears below with a chart showing the closing level for VXST on each of those record days in 2014.  The average for VXST when the S&P 500 makes a new high in 2014 has been 11.  The last four record highs have come over the past couple of weeks and although trending down to the average level, VXST is still a bit higher than when the market set those previous records.   In behavior terms this means the market is pricing in more risk than it has when previous records were set.

VXST All Time Highs

VXST did drop 19.35% last week as more records were set.  What I find interesting below is the far right side of the curve where despite quite a drop in VXST the futures that expire four weeks out were only down 0.30.  This sort of reinforce the view I gathered from VXST pricing in a little more risk relative to previous all-time S&P 500 highs.  It appears option traders continue to be braced for one more draw down before the end of 2014.

VXST Curve

As always – if you want to learn more about VXST visit the following link –

www.cboe.com/vxstms

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