A return to normalcy occurred last week with the 18% drop in VIX and 3.26% rally in the S&P 500. Even the seasonal December pattern moderated a bit and we have a textbook contango curve for the first time since August.
In Chicago we are already getting use to the Bears getting pummeled each week. This past week bears everywhere took it on the chin as the S&P 500 put up the best weekly performance in 2015. What I find interesting on the chart below relates to VIX, which was down 18.4% for the week, which is actually the fourth worst week for VIX this year, despite VIX beginning the week over 20.00.
VXX dropped about 11% and SVXY was up closer to 12% last week. However, the choppy year is resulting in losses for both funds (so far) in 2015. A number that stands out to me on the table below is the VIX of VIX (VVIX) which finished the week at 89.08. This is at the higher end of a longer term range and indicates demand for VIX calls remains high despite (or maybe because of) the recent drop in VIX.
Two trades from Friday in VXX caught my eye, both are bullish on volatility (bearish on the stock market), but have differing levels of bullishness. First there is was a bull put spread initiated mid-day on Friday using the series expiring on October 16th. A trader sold the VXX Oct 16th 21.00 Puts at 0.67 and purchased the VXX Oct 16th 19.00 Puts for 0.04 and a net credit of 0.63. This all happened when VXX was trading around 21.05, so any spike in volatility next week would probably result in the trade being a profit, while the normal price action for VXX if VIX is steady or lower next week may result in a loss with losses being capped from 19.00 or lower.
The second trade has a little bit longer time frame, using options that expire on October 30th. This trade is pretty darn aggressive as the VXX Oct 30th 24.50 Calls were purchased for 0.72 and the VXX Oct 30th 27.50 Calls were sold at 0.36 and a net cost of 0.36. At the time VXX was trading at 21.65. To get the full profit VXX needs to rally about 27% by the end of October. For VXX this certainly is not out of the question and October is the kind of month that historically experiences increased volatility.
In the past two months, several global volatility indices such as the CBOE VIX have been in the spotlight as they rose to the highest level in months or years. What have been the drivers of this recent market volatility and how did the volatility indices react to that? In a recent video interview, I spoke with one of VIX Views’ authors, Matt Moran, Vice President, CBOE, to answer these questions.
Despite the S&P 500 rising over 1% last week VIX remained over 20.00 for the 30th straight day although it did drop by over 11%. This run goes back to the beginning of the heightened levels of volatility that began back on August 21st. The curve below shows that the curve based on standard monthly VIX futures went from backwardation to kind of crooked (that’s not a technical term). I say crooked because depending on your definition of backwardation or contango the closing curve on Friday could be considered either.
The short term curve went from backwardation to basically flat which is what I anticipate will be considered normal. We only have about 10 weeks of short term futures data to work with so I haven’t come to a conclusion on what will be ‘normal’ for VIX Weeklys futures.
Finally, a trade example that I found pretty interesting as well as smart from Friday. Toward the end of the day there was a ratio spread that works as long as VIX is under 35.40 at November settlement. The specific trade sells 2 VIX Nov 30 Calls at 1.10 each (2.20) and buys 1 VIX Nov 25 Call at 1.80 for a net credit of 0.40. Both VIX and the November contract were in the 20 to 21 range when the trade was executed so I show where both finished the week last week on the payoff below.
Those that casually watch VIX may not be aware of the variety of volatility indexes published by CBOE. On at least a weekly basis I take a look more than VIX and try to gain a little insight into the mind of the market. The curve below shows the relationship of four volatility indexes that represent consistent measures of implied volatility as indicated by S&P 500 (SPX) index option prices. What has been catching my eye since excess market volatility started to commence on August 21st is the relationship between VXV (3-month) and VXMT (6-month). Note the section of the curve highlighted by the purple box in the chart below and I’ll explain more below.
Since August 21st 3-month volatility has been at a premium to 6-month volatility on the close 25 of 30 trading days. Going back to early 2008 the shorter dated focused VXV has closed at a premium to VXMT about 13% of trading days with about 2 out of 3 of those closing levels occurring during what we refer to as the Great Financial Crisis in 2008 – 2009.
My interpretation of VXV being at a premium to VXMT was that the market was braced for Fed action at one of the two meetings left in 2015 (most likely December). VXV measured the nearest time frame just after the last meeting of 2015 and the one many pundits seem to be focused upon. With the market rally in reaction to the employment number this past Friday VXV dropped below VXMT. I heard calls that a hike may not occur until 2016 on Friday, but I’m not one for opinions, I like to see what the numbers tell me. Implied volatility is forward looking measure which can be used to gain insight into Mr. Market’s mind. If VXV remains under VXMT consistently over the next few trading days I’ll see that as the numbers agreeing with the pundits looking to 2016 for the first rate hike in my children’s lifetimes.
The S&P 500 rallied over 1% last week with all the gains coming from Friday. VIX dropped, but remained above the 20.00 level to extend the consistent number of closing days over 20.00 to 30 in a row with the streak going back to August 21st. The S&P 500 rally put pressure on the long funds with the leveraged long guys really taking it on the chin, againg with the price drop mostly being attributed to Friday.
Over the last hour of the day on Thursday this past week there was a pretty aggressive buyer of UVXY Oct 2nd 56 Puts. They purchased about 1500 contracts over the course of an hour. The best I can guess is the average price came to about 2.40. Over the last hour UVXY prices averaged 56.30 although the range for UVXY over this period was wider than a point. The payoff at expiration, which was Friday this past week, appears below.
I often refer to the monthly employment report as being like an earnings announcement for the equity market. When I make this sort of statement I’m usually referring to the price action of SPX and VIX options. I guess I need to broaden my focus and include the VIX related ETPs and their associated option markets as potential ways to play employment. The result for this trade was pretty positive for the put buyer as UVXY was down dramatically on Friday which placed the UVXY 56 Puts exactly 7 points in the money.
Presentations on topics such as (a) the relationships among price movements of stock indexes, the CBOE Volatility Index® (VIX®), and the India VIX Index, and (b) new studies on fund use of options and volatility-based strategies, will be delivered by me to continuing-education meetings of the Indian Association of Investment Professionals (IAIP) in the cities of –
Below are some of the topics I plan to cover in the presentations in India.
VOLATILITY INDEXES SKYROCKETED IN AUGUST
Investors often examine volatility indexes to gauge changes in investor sentiment. In the past two months several worldwide volatility indexes have been in the spotlight as they rose to their highest levels in months or years. In August, for example, the popular CBOE Volatility Index® (VIX®) reached a high of 53.29, and the high for the India VIX Index was 35.57.
The India VIX Index is one of several volatility indexes worldwide that has been legally licensed to use the methodology that is used for the CBOE Volatility Index (VIX). The website for the India VIX notes that —
“India VIX is a volatility index based on the NIFTY Index Option prices. From the best bid-ask prices of NIFTY Options contracts, a volatility figure (%) is calculated which indicates the expected market volatility over the next 30 calendar days. India VIX uses the computation methodology of CBOE, with suitable amendments to adapt to the NIFTY options order book using cubic splines, etc.”
IMPLIED VOLATILITY DROPPED IN EARLY SEPTEMBER
A September 9 story on Bloomberg news by Santanu Chakraborty noted that
“Indian option costs fell for a third day, reflecting reduced demand for protection against equity-market swings, as the CNX Nifty index extended its rebound from the lowest level in more than a year. The India VIX index, the benchmark gauge of equity-option prices, dropped 1.1 percent to 24.3 at the close in Mumbai. The 50-stock Nifty index rallied 1.7 percent to 7,818.60, rising for a second day after closing near a 14-month low on Monday. The price of the Nifty 7,500 put, the contract with the highest open interest, slumped 26 percent. Implied volatility dropped as optimism that China will be able to stabilize its financial markets boosted risk appetite around the world. …”
NEGATIVE CORRELATION FOR VOLATILITY INDEXES
A key reason that many investors are intrigued by volatility indexes is the fact that volatility indexes often have had negative correlations with stock indexes and other indexes. Note in the table below, for example, that the S&P 500 Index weekly returns had negative correlations versus the VIX Index, the S&P 500 VIX Futures Index, and the India VIX Index.
VOLATILITY INDEXES CAN EXPLODE TO THE UPSIDE
The table below shows all the weeks since 2007 in which the S&P 500 Index rose or fell by more than 5.5%. Note that in all the eleven weeks that the S&P 500 fell by more than 5.5% —
(a) The S&P GSCI Index also fell in each of the 11 weeks – this fact could have made diversification more challenging;
(b) The new CBOE S&P 500 5% Put Protection Index (PPUT) usually also fell, but it did not fall as much as the S&P 500 Index because it held protective put positions;
(c) Both the VIX Index and the S&P 500 VIX Short-Term Futures Index had big gains all 11 weeks. The all-time biggest percentage rise for the VIX Index in one calendar week was the 118.5% gain the week ending August 21, 2014.
I am looking forward to the events with the presentations in India this week.
For more information on the topics covered above, please visit www.cboe.com/volatility and www.cboe.com/funds.
Investors who wish to hear expert discussions of options and volatility could register for an upcoming CBOE Risk Management Conference (RMC) —
4th Annual RMC Europe: Monday – Wednesday, September 28-30, 2015 at the InterContinental Hotel, Geneva www.cboermcEurope.com
1st Annual RMC Asia: Monday – Tuesday, November 30-December 1, 2015, at the JW Marriott Hotel, Hong Kong www.cboermcAsia.com
32nd Annual RMC US: Monday – Wednesday, February 29 through March 2, 2016 at the Hyatt Regency Coconut Point, Florida www.cboermcUS.com
On the traditional VIX curve we saw a pretty dramatic shift of the upside across the board. The exception was spot VIX, but we have to attribute the smaller move to the three day weekend effect that causes VIX to close a little lower than if we were approaching a 2 day weekend. A couple of things catch my eye on the term structure chart below.
First, the price difference between September and October has me scratching my head. On Friday we kept hearing how the employment number may impact what the Fed decides to do on September 17. If that were really the focus of the market I would think that the VIX future that expires after the announcement would not be at a 2.25 point discount to the contract that settles the day before the Fed’s next announcement.
The second thing that really impacted me was how much the farther end of the curve gained last week. As VIX remains in the upper 20’s the market is adjusting for this sort of higher volatility environment to continue for the next few months.
The near dated futures curve shifted higher as well. The September 9th future finished the week at a premium of 0.45 to spot VIX which I will attribute to the expectation that VIX will get a small boost after we all celebrate Labor Day. With this being a holiday weekend, that contract has one more trading day and then it settles on Wednesday morning.
On Friday, as VIX rose and the S&P 500 dropped I went searching for trades to discuss this weekend. Instead of a specific trade, I’ll just throw a theme out there. Every big trade I saw was a seller of volatility, either through selling out of the money VIX calls or selling call spreads with the majority of this action focused on the September contracts.
The S&P 500 lost 3.4% last week which I guess is becoming commonplace these days. Do note on the curve below that VXST closed a tad lower on a week over week basis. We attribute this to the long weekend we are currently experiencing and I’ll address that a little more in a minute.
Both VXST and VIX experience a little bit of a headwind going into long weekends. This can be attributed to the calculations of both being based on calendar days and not trading days. Therefore when the market is closed for three days the result is a slightly lower index than before a non-holiday weekend. In the case of VXST this impact is more dramatic since it is a nine day volatility measure. We have data going back to 2011 for VXST and of the 30 long weekends over this time period VXST has dropped 22 times on the Friday before, but risen 29 times on the day after the long weekend. So based on history we have a 96.7% chance of VXST rising Monday.
The combination of the drop the in S&P 500 and move higher in VIX futures benefitted the heavily traded VXX last week which rose twice as much as VIX. In addition to VIX futures gaining value last week, VXX benefitted from the continued state of backwardation between the September and October VIX futures contracts. For those keeping score VIX month 1 – month 2 backwardation has been in place for 11 consecutive days.
Despite the state of backwardation, one trader did a pretty good job selling volatility on Wednesday this past week. With VXX hovering around 30.00 there was a seller of the VXX Sep 4th 30.00 Calls at 1.18 who then got some protection from buying the VXX Sep 4th 31.50 Calls for 0.60 thus taking in a net credit of 0.58. The goal here is VXX closing under 30.00 on Friday, which it did after making a few small moves over that key level during the trading day. If the trader sweated it out and held to the close they were rewarded with a profit equal to the credit of 0.58.
VIX® Weeklys futures began trading at CBOE Futures Exchange (CFE®) on July 23, 2015. VIX Weeklys options are expected to begin trading at CBOE® on October 8, 2015. One of the most important features of the new VIX Weeklys is the fact that these products have the potential to provide more trading precision and responsiveness for investors.
Note in the first chart below that the VIX Weekly futures (Wk 34, expiring on August 26) generally were much more responsive than the VIX futures with standard expiration in September and October. In the three trading days ending on August 24, the S&P 500 Index fell 9% and the VIX Weekly futures (Wk 34) rose 147%.
It is interesting to compare the charts above and below and note that the SPX put-call ratio jumped as the VIX Index rose. More Precision and Responsiveness. The addition of weekly expirations to standard monthly futures and options expirations offers volatility exposures that more precisely track the performance of the VIX Index. The closer VIX futures and options are to expiration, the more closely they generally track the VIX Index. By ‘filling the gaps’ between monthly expirations, investors may obtain new opportunities to establish short-term VIX positions, and fine-tune the timing of their hedging and trading activities.
Ticker Symbols. Quotes for VIX Weeklys will be listed within the existing VIX futures and options chains. More information is at www.cboe.com/VIXWeeklys.
I’m depending on my aging mental capacity in lieu of spending the time to go through the last four years of VIX recap blogs for the following statement. I have no recollection of a shift in the VIX term structure curve that replicates what shows up below. VIX lost value on the week, while all the futures contracts moved higher. Last Friday, spot VIX ran up quickly at the end of the day, but the futures remained at lower levels. To get back to a more ‘normal’ environment, we needed either a drop in VIX or a rise in the futures pricing. We actually got both with the front month September contract gaining almost 23% while VIX dropped by 7%.
The next chart and table is relatively new to this space and is a depiction of VIX and the next five weekly VIX futures contracts. For an apples to apples comparison the contracts are consistently rolled. So Week 1 on 8/21 was the August 26th contract while Week 1 for 8/28 is the September 4th contract. Do note that a week ago the near term future was at a discount of 3.255 while this past Friday the near term future is basically in line with spot VIX (for the quants it is actually at a slight premium).
As the week came to an end, which could not have come too soon for most traders, there was a fairly aggressive bear call spread traded in the VIX pit. There was a seller of the VIX Sep 16 Calls at 9.00 who also purchased the VIX Sep 20 Calls for 5.94 for net credit of 3.06. The payout at September expiration along with where VIX and the September future finished the week shows up below.
At expiration the trade makes money below 19.06 and if we get a dip to 16.00 or below then both call options expire with no value and the trader gets to keep the credit of 3.06 that was taken in when the trade was initiated.