As the Market Drops, and the VIX rallies, Real IV is Down

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The more I look at what is going on the in the market place, the more I am convinced that the eerie non-movement of implied volatility is part of the big bet. Traders were short the S&P 500, long Oil, and maybe even short the dollar.  Oil might be substituted for metals as well.  That could be part of the reason the market was down almost 16 handles today, yet the VIX was up less than 1%.

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The idea behind the above trade is that traders were betting on a 'decoupling' of the different products.  For instance, back in 2008 as Oil rallied the SPX began to fall, but it didn't start to happen until oil began breaking 110-120.  Once that happened, look out, every day oil was up SPX was down and vice versa.  The dollar was getting smoked, which seemed inevitible.  What makes trade seem somewhat better is that while the trades are coupled, SPX puts make a decent hedge against oil, or so these traders thought.  The problem:

The trade didnt decouple and IV's are not increasing as the market is falling.  Owners of these puts are getting smoked by time decay in SPX and losing big dollars in Oil.  In a falling market, stable to falling IV's are even more killer to a portfolio then the call crush.  Why, because most traders prepare for a vol crush on a rally, not on a market selloff.  My understanding is that there are some traders getting killed out there as Oil has tanked and SPX puts have gained little value beyond delta.  I cannot imagine they like what they are in; however, in the end they may be right.  It goes to show you that when one thinks they have things figured out, they probably do not. 

In this case, despite the VIX being up, if I pull apart the SPX line by line one can see how IV has really moved over the last two weeks, and how it was down today and are flattish all the way down:

The 1270's:

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The 1325's:

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The 1350's:

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As I taught the Pit Report today, I could not find a single trade I liked aside from one small trade.  This was a day to sit on my hands.  I had a very smart option mentoring student say something very interesting about how IV is not falling.  I pointed out how eerie the market seemed, at which point the ‘Bernanke Put’ was brought up.  The students said this:  ‘Everyone thought there was a Greenspan Put in 2008, and there wasn’t.” 

A great point, insurance is in relative terms cheap, I would use it.  Also, I am noticing that skew is STARTING to flatten up, keep an eye out for butterflies.  Those seem to be the trade right now.  

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