The big surprise for me is the lack of interest in volatility into the NFP on Friday. VIX notched its 5th straight decline going into a big number which is something I don’t remember happening in the QE period since the first talk of taper began. VIX could easily pop back up tomorrow but for now I would not trade it.
The hopes of the weekend budget resolution faded this morning only to be resurrected by midday. The debate over the budget is turning the global equity markets into one big binomial trade. The two parties agree we rally, they don’t we crash.
If the stock markets are having a hard time, think about the volatility markets. One thing Black Scholes did not think of was the impact of liquidity on option prices. They thought about it, but it is really not in the model. The only proxy for liquidity is volatility in BS. Right now the volatility market is squishy like Jello. Jello looks solid but you can push you finger right through it and it wiggles when you move it.
There is no doubt we have had a whippy couple of days. Just when I though the Taper, FOMC and NFP were going to dominate the news along comes the Middle East dictator of the hour accused of using chemical weapons. This is an unfortunate and sad chapter for Syria as the Arab Spring tries to flower in other countries. For now rebels are stuck in a bit of stalemate and according to news accounts the Syrian Government is trying something new to break it. That brings repercussions from the US and possibly the UN. That is where we are and now the market waits.
Since this is a volatility blog we will get out of politics and into the trade. The two things happening today are:
Just coming back from an extended vacation I was surprised to see the market not making all-time highs. The only stock that seems to be there is TSLA but that is for tomorrow’s column. A weak ADP report and a balloon by a Fed governor was enough to send the market down 1.4% today. Mark commented yesterday on the frog in the pot (in Maine that would be a lobster in a pot but they don’t jump) for a volatility metaphor and it reminds me of the phase “volatility begets volatility”.
Yes I made that word up. I make them up all the time during the Pit Report. I was looking for a phrase to describe the activity, and it was hard to put things into words. Essentially market participants want return without taking risk, and then complain when they lose. The market for risk has become "sissified." The trend was started with the bailout of Mexico in the early 1990s and went to Asia, sort of hit the USA with LTCM and is now stuck in Europe where it will remain for some time. I think Europe had their Lehman moment and things got a little ugly after that. You might say TARP, but that was loan guarantees against bank assets.
The last post of 2012 is a little bitter sweet. Overall a good year for equity returns but I can’t shake the feeling that we missed something and the market is holding back. Most of the big issues of 2012 are not on the front page anymore. Much like the end of 2011 a few loose ends are hanging around. One thing I find telling is that the bond prices (measuring by the TLT) did not continue their move to outpace equities. The Fed is going to keep buying but that rally looks like it is coming to an end. The most crowded trade of 2012 is ending up around nowhere as I have TLT up around 1% YTD before dividends. Here is my last snap of equity volatility going into 2013.
Not the best grammar but I wanted an attention grabber.
Did anyone catch the volatility markup at the end of the day today? We had fairly solid preopening activity this morning, but news of the budget standoff sent the market into a small tailspin. The volatility players are in the serious business of trying to handicap the outcome of the Fiscal Cliff talks. Yesterday players were pricing in a much better shot of things going through earlier than not. VIX traded as low as 15.57, as it sold off most of the day yesterday. After an aggressive print on VIX settlement this morning, volatility traders started buying options in Jan cycle for the big indexes.
As we discussed on Tuesday, VIX was not just pricing in the cliff, it was pricing in the non-farms that came out today. While the December contract really hasn't moved since then, the Cash Index has come in considerably. The curve closed the day basically back to normal contango, albeit a relatively flat contango.
Well the good news, at least from the markets perspective, is that the ECB outlined some kind of plan for buying and supporting Euro area debt. For the most part, it was the same assembly of loose promises and goodies, but that should be enough to get the animal spirits rolling in Europe until the end of the week. Add to that a pretty decent ADP payroll report that seems to point to employers getting past the tumult of last year’s crisis. The SPX cash closed over 2% for a big relief rally. Here is where it gets weird.
Our COO was on Bloomberg's Lunch Money today discussing trading and options order flow on Chesapeake Energy. You can watch the Video:
One of the things we have been trying to do, along with Mark's Bloomberg appearences, has been to try and explain the Why of the trade, in hopes it will educate potential option traders about options. Here is an explanation of the trade itself.