As I looked through the stats of today's market selloff, I noticed a few interesting things. The most significant was this: for how much the SPX was down, IV did not seem to rally very hard. In February of this year, the SPX dropped about 23 points, the VIX rallied almost 4.5 points (adjusted for the weekend, closer to 3.75%). Today, the SPX fell 30 handles (bigger in absolute and percent movement than the February fall), yet the VIX couldn't even rally 3 full points. I have arrows pointing to the two days on the chart below (note the Red is LiveVolPro’s version of the VIX, not the VIX itself):
Notice how much bigger the rally in February was. The next thing I noticed was VIX June futures and VIX cash went into a slight contango near the end of the day.
While some are pointing at this as a potential reason for today being a market floor, I do not see it that way. I tend not to pay as much attention to the front month futures once they get inside of two weeks. At that point I will start looking at the second month (in this case July), or one could follow the CBOE's Russell Rhoads. He has a somewhat VXX like methodology in calculating VIX cash to VIX contango where he will blend front month futures. It’s pretty effective, and since it is only an indicator, it has all the benefits of VXX and none of the horrible contango decay problems.
I would point out that neither Russell's indicator or VIX July futures went into contango. July is trading at a hefty 1.6 percent premium to June futures, even with today's rally in June futures. This means there is plenty of room in the futures for the market to continue to sell off. And while we are seeing some interesting paper in the SPX (ill get to that in a minute), there was copious amounts of VIX call buying today. Basically, I will begin to believe we are near a bottom only when I see Russell’s indicator fall below VIX cash.
Another volatility indicator that is creeping me out is the VXX. Despite the front two months trading at a contango of about 1.6 percentage points, the VXX went easy to borrow today (this means that if one wants to short this stock, one can easily go out and borrow the stock. The VXX is normally extremely hard to borrow). This is somewhat significant because it typically only happens when the front two month futures are trading at little or no contango. There is an anticipation of this contango tightening, or IV is about to pop. The later two both point toward a sell off (the former is a sign we are bottoming).
So with all of this doom and gloom, why is the VIX not keeping up with SPX? Traders are selling puts into this sell off. Despite a 30 handle drop, and plenty of reasons for there to be put buying, take a look at the change in net deltas and net premium in the SPX today:
Traders sold over 100 million dollars worth of net premium today. Not only that, it appears they almost exclusively sold puts into the market today. What is fascinating is that traders didn't even try to take the less risky way to get long by buying calls; almost all long deltas were a put sell (They wanted the short vega and long delta). They are doing this because it keeps working. Every time the market has sold off, if one was willing to stick a leg out and sell puts, over the next few days the trader made a killing.
The problem is at some point this strategy is going to stop working. Based on a few of the major sales I saw today: the June 1300's, the July 1300's and 1310's and the July 1275's, and keep an eye out for 1300 in SPX. If the market breaks 1300 and can't bounce back, I think we will see traders hit the panic button. On a day like that we could see the VIX up 3-4 points even if the SPX is down only 15 or 20 handles.
What to do?
On a day like today, I tell my traders you will never sell the top in IV. Wait until tomorrow. If the market isn't down big, then you can enter in the market. There is no point on selling into the beginning of a sell off. If this is just a blip, selling a VIX of 17.50 is not much worse than a VIX of 18.25. Personally, I think the market has plenty of room to fall from here. I think we bounce off 1300, or we head straight down to 1250 (1250 would put the VIX near 25-28%). There will be opportunities to sell into this, but I am glad I did not do any premium selling today. I will be happy to collect whatever I get tomorrow, if this selloff amounts to nothing.
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Tomorrow: the State of Volatility in the SPX
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Graphs from: LiveVolPro data from CBOE
