Market Recap – October 15, 2013

Ultra-short post tonight. Not much to say until we get a debt deal passed through Congress and we see the market’s response. Until then, we should expect to see more chop. As we can see below, the VIX term structure (courtesy of TradingVolatility.net) is demonstrating the current indecision of investors.

VIX term structure chart

After a deal is done, though, we have to ask “what next”?  At best, any deal just kicks the can down the road a little. Neither side seems interested in addressing the underlying deficit issue.

As for my trading plan, I’m in cash now and looking for a strong trend to emerge. As a backdrop to my trades, I am watching two things:

  1. Quarterly earnings – are margins staying elevated or are they starting to see pressure?
  2. Will the markets reverse the latest trend of waning participation with each new high?
    • This is the one I am watching most. This trend does not favor the bulls.
    • See below for a chart from DecisionPoint.com ($) illustrating the trend.

Disclosure(s): None

NYSE New Highs/New Lows

UVXY shares “hard to borrow”? No problem.

DISCLAIMER: This is in no way a recommendation to establish a synthetic short position in your account. It is for illustrative purposes only. You take full responsibility for your trades.

 

I’m throwing this post out there, despite a fear that it will coincide with a precipitous drop in the market. As every active investor knows, we have recently experienced a spike in the VIX from well below average to just over its long-term average value of 20. This leaves plenty of room to the upside.  That said, I would prefer to share this now, rather than after the VIX falls and the markets rally.

I often hear traders express frustration over the desire to short shares of UVXY (or other stocks or ETFs), but they cannot because the shares are marked as “hard to borrow”. Fear not…there is another option…through options! (bad pun intended)

The answer is a synthetic short position. The Options Guide does a great job explaining of how it works.

For this post, I will only touch on the synthetic short, which essentially carries the same risk/reward of directly shorting a stock. The Options Guide contains many more strategies that help limit downside risk.

Using yesterday’s closing values, we get the following table (from Charles Schwab).

UVXY option quotes

To create a synthetic short position of 100 UVXY shares, I would sell one call option and buy one put option, both with a strike price of 42.00. In selling the call (at the bid), I would receive a $4.50/share credit (x100 shares, or $4,500) for selling the call and pay $4.50/share (x100 shares, or $4,500) to purchase the put (at the ask).

To be clear, while the two cancel each other out and it may look like no money has left my account, I am now synthetically short 100 shares of UVXY and my position carries the same risk/reward profile. Knowing this, brokerages will require a certain amount of margin in the account to maintain the position.

The chart below describes the financial impact of various price moves on the underlying stock, UVXY:

UVXY synthetic short payoffDisclosure(s): None

Market Recap – October 9, 2013

First, a couple of must-read blog posts (coincidentally, both with poker themes):

Second, a few of my usual daily reads:

It seemed like the market wanted to show capitulation today and start a relief rally, but then sold off to end flat at the close. VVIX (volatility of volatility) hit 120 today. I have found that elevated readings in the VVIX have often coincided with great times to open a short position on volatility, provided a few things:

  1. One manages position size properly. An elevated VVIX means volatility (VIX) and the ETFs that track volatility (either directly or inversely) will also be volatile and one can be easily stopped out or damaged in the whipsaw action.
  2. The trader has a trade horizon of at least a few weeks. Massive returns don’t immediately follow a VVIX spike to 120. Good trades require some patience.
  3. The VIX term structure remains in contango. The last two spikes to 120 were in May 2012 (close, actually 117) and November 2011. Both were great times to short volatility. We also saw a spike >120 in August 2011, but that marked the beginning of an extended period of backwardation in the VIX term structure. Traders shorting volatility in August 2011 were crushed over the next few months.

I opened a small short position on UVXY early in the afternoon, but closed it about 10-15 minutes before market close. I did this for a few reasons — 1.) momentum of the reversal seemed to be waning and 2.) I would rather lock in quick day-trading profits than hold overnight positions until momentum in $SPY is clearly to the upside. I expect to continue dabbling in and out of small, opportunistic trades until a more positive trend resumes.

I still believe we will see a short-lived relief rally followed by more downside action in the intermediate-term, but I will keep an eye out for alternative scenarios.

Today’s charts are below, courtesy of StockCharts.com and Trading Volatility.

Disclosure(s): None

SPY daily chart VIX term structure chart $NYMO $BPSPX $USHL

Market Recap – October 8, 2013

Volatility posts of interest from today:

As I tweeted a few weeks ago, I closed my short position on volatility completely by Sept. 26. I remain in cash now, but I am looking for an opportunity to short volatility again.

My current market hypothesis is that we are due for a bounce, but we may see more selling before the bulls regain control. Important factors I’m watching include:

  • VIX – we’ve seen a spike above 20…but remember, the long-term average is 20. I’d prefer to see a value in the high 20s or more before I “back up the bus” (by shorting volatility).
  • VVIX – hit 110 today; this is a good sign; tradable bottoms are often found when VVIX hits 110 or higher.
  • VIX term structure – near-term part of the curve is in backwardation, but long-term portion is still in contango
    • First, this tells me the current market fear is a short-term concern…and that when that fear starts to subside, near-term volatility is likely to drop fast.
    • Second, this means I do NOT want to be short VXX, short UVXY, or long XIV near-term backwardation exists. The tide is working again the “short volatility” trade right now.
  • Volume – we have started seeing a spike in volume in the major ETFs (SPY, IWM, QQQ), as well as the volatility ETFs (VXX, XIV, and UVXY). I would prefer to see spikes in daily trading volume of 3x the average. We are close, but not there yet.
  • Momentum – to be comfortable with a longer-term “short volatility” position, I want to see bullish market momentum. The last few weeks have seen bearish trading.
  • New Highs/New Lows (in the S&P500) – highs have contracted, but we have yet to see a spike in new lows (representing excessive bearishness).
  • Spike in my blog traffic and # of twitter followers – despite taking a blogging hiatus the last few weeks, I have seen a spike the last two days. Investors seek greater information during periods of uncertainty.

Today’s charts are below, courtesy of StockCharts.com and Trading Volatility.

Disclosure(s): None

SPY daily chart VIX term structure chart - backwardation $NYMO $BPSPX $USHL

Market Recap – September 18, 2013

This market continues to frustrate the bears…or at least anyone who is 1.) short equities, 2.) sitting in cash, or 3.) long volatility. I agree with the voices that claim the market is overvalued on a fundamental basis. Unfortunately, the markets have a history of remaining under- or overvalued for extended periods of time. This time is no different.

Besides, the Fed seems intent on inflating us out of our debt problem. Rather than punishing over-spenders, they are punishing savers. Savers who invest on fundamentals are getting punished the worst.

Despite today’s large, downward shift in the VIX futures term structure, VIX month 1 contract (October) is still trading ~8% higher than the VIX spot index…a healthy gap. The entire term structure is firmly in contango.

Overall, the trend in equities remains up. Sure, we could be in a topping process, but if you are expecting a “crash” (a legitimate one…not a 3-5% move), you will highly likely be disappointed. Momentum is firmly to the upside, we are making new highs in the indices, the # of underlying stocks making new highs continue to expand as the market advances, and volatility continues to decline (both implied and historic).

These are not the signs of a pending crash. …not to mention the fact that true crashes are rare. It shocks me how often “experts” call for crashes, despite the relative infrequency with which they occur. I guess selling fear helps drive TV ratings. I’l stick to selling the VIX…much more profitable.

Today’s charts are below, courtesy of StockCharts.com and Trading Volatility.

Disclosure(s): Short volatility at time of writing.

SPY daily chart VIX term structure - contango $NYMO $BPSPX $USHL

 

Market Recap – September 09, 2013

A few volatility reads for the day:

Strong day in the markets as $SPY tacked on nearly 1%. Despite the below-average volume, we saw an expansion of new highs and momentum indicators are starting to point up. I don’t think we are completely out of the woods, but this bounce/rebound has been gaining strength.

As I mentioned last week, I looked into realized (or “historic volatility” – HV) against forward looking (or “implied volatility” – IV) and what that meant for near-term market returns. Not a ton of exciting results to report, except that there seems to be at least a correlation between a the premium of implied volatility over historic volatility and positive market returns. In more simple terms, when IV > HV, the market has gone up (on average) over the next 20 days. When IV < HV, the market has tended to perform poorly over the next 20 days (on average).

I would need a lot more research time to pull tradable recommendations out of the data…but I’m sure there are some juicy things in there. Saved for another day…

Today’s charts are below, courtesy of StockCharts.com and Trading Volatility.

Disclosure(s): Short volatility at time of writing.

SPY daily chart VIX term structure chart - contango $NYMO $BPSPX $USHL

 

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