Russell Rhoads draws a great analogy between volatility spikes and a famous incident in show business history:
On May 6, 1994 Robert Francis Goldthwait made his...
In response to my earlier post on why options markets are being overly sensitive, Eli Mintz offered an interesting alternative explanation of the data:
@condoroptions My interpretation is more benign. I think that the market is just pricing lower average volatility long term.
— Eli Mintz (@VixCentral) April 30, 2013
Here’s why this is a plausible explanation of those recent flattening periods in the VX slope. If the market is expecting lower volatility over the long term,…
One of the most important market signals over the last five years has been the slope of the VIX futures term structure. In quiet, bullish markets, short term option premiums are significantly lower than longer-dated implied volatility; when risk scenarios roil markets, the term structure flattens and then steepens in the other direction. Changes in that dynamic have more explanatory power than many of the technical signals and chart patterns favored by directional traders.
Since December 2012, however, changes in the…
Everyone knows that implied volatility and stock returns tend to be negatively correlated. The results from a recent study we did showed, though, that when implied volatility and stock returns become too negatively correlated, volatility sellers should consider moving to cash.
The x axis in fig. 1 shows the two month realized correlation of VXX and SPX returns. The y axis shows VXX returns 15 days after each correlation observation. One thing that stands out from this plot is that, if we…
Most traders understand that a “buy low, sell high” approach applies to options markets just as well as it does anywhere else: when options are overvalued, it pays to be a net seller of that premium. But “overvalued” often has nothing to do with the level of implied volatility you might observe on a chart. Options are usually well-bid for a reason, or are cheaply priced for a reason. Finding an asset where volatility is truly under- or overvalued depends…
Since early 2012, hedge funds and other traders have been short S&P 500 volatility via VIX futures in sizes not seen before. A story from IFR was syndicated across Reuters last week with a rather provocative lede:
Hedge funds have levered up their short plays on VIX futures to such extreme levels that the market is poised for a significant short squeeze.
For context, here is the positioning in VIX futures by non-commercial traders since the product was listed…
Monday’s 1.9% decline in equities sparked the largest jump in the VIX since…
There’s certainly some value in knowing the end of that sentence, but unless you’re avoiding all financial media, you’ve probably already read a few variations of that story. Here are some additional ways of measuring changes in implied volatility. We use some of these estimates to inform market timing strategies.
First, here is the VIX shown as a percentage of trailing S&P 500 1-month historical volatility. Sometimes…
As tail risks have fallen aside and markets have normalized over the last several years, most of the strange market phenomena from the financial crisis have reversed themselves. Housing prices have firmed up as supply tightens, lending standards have relaxed, and correlations among dissimilar assets have fallen back toward historical norms.
One aspect of the market that has not yet normalized is the relationship between short- and longer-dated option premiums. Near term option implied volatility has fallen to levels in…
Japanese stocks have been on a tear since last November. The Nikkei 225 index is up nearly 25%.
Most of the time, stock returns and option implied volatility move in opposite directions. Since 2007, the correlation of daily S&P 500 returns and the VIX was -0.768. The intuitive explanation for this relationship is that equity holders are less likely to raise their bids for options when stocks are stable or are rallying. Based on that relationship, and given the size…
A successful portfolio hedging strategy does two things: it protects against market declines, and it imposes minimal costs in rising markets.
In a year like 2012, the ability to minimize hedging costs actually matters more than downside protection, and the VIX Portfolio Hedging (VXH) Strategy bested its benchmarks and peers by being more cost-effective.
Let’s start with a look at how the S&P 500 and the iPath VXX ETN fared in 2012. The histograms at fig. 1 show daily…
Thursday, May 9, 2013
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