When I think about times where I have seen new option traders lose a lot of money, there are a few that come specifically to mind. Early in the process, we work very hard to teach our option mentoring students proper risk management. Some of it is simple; it doesn’t take long to show someone how throwing money at a problem is not a good way to solve the problem. However, some will drive my option mentoring student’s nuts. One of the hardest to teach is killing a trade that is only modestly a loser but has changed assumptions in the trade.
If I hear an option trader/option education student call this VIX low again, I might scream. Here is why:
If I told you that over the last 9 trading days that the market had moved a total of 9 points, where would you expect the VIX to be? Would it be 20, 15, or 10? Well, if we consider that over a 9 day period that equates to volatility in the super low single digits, and that implied volatility typically sticks to 2-4 point premium, that would put the VIX below 10.
Well, we have had movement of 9 points in the market over the last 9 days:
We are constantly correcting our option mentoring students about the state of the volatility. The VIX is NOT cheap. It is expensive, not on a historical level, because from that perspective it’s about normal. But it is on a relative level. Check out the continued spread between 10 Day HV and 30 day IV.
One of the things we focus on in our option mentoring is understanding VIX. We teach our option mentoring students to watch the relationship of VIX cash and VIX futures, as they can get out of whack. Well, let me tell you, they are WAY out of whack right now. A great resource to watch the VIX futures is VIX Central. On the site, Eli not only has the current VIX curve, but the curves of every date going back to 2008. Here is the curve from today:
Option traders, we are going to take a small break from the VIX and talk economics and the market rally. As the SPX touched 1425 today, a little piece of me was satisfied about the rally. After all, we have been calling for this slow rally for some time. Why? Well, for starters, we felt like it was a good time to play counter-trend to sentiment. Then, looking at the relationship of VIX to SPX, we were seeing confirmation of a rally in the relationship between the two. We played it and are happy we did.
This is the question so many of my option mentoring students are asking me. I also get tons of questions from the option profits people on this as well. In fact, just about everyone wants to know if the VIX HAS TO RALLY???
The answer is, hisoricially, yes, but in relative terms, the answer is in the graph below. Take a look at this chart of 30 day IV relative to the last 10 days of trading (the Red is 30 day IV):
Generally speaking, I think my take on which direction the market has been heading is about as good as anyone else's(and by that, I mean worse than a monkey throwing darts). However, there are times where I feel certain about my market inclination. Right now, that inclination is up, and I will tell you why.
One of the important factors that I follow is the price of the VIX relative to the SPX. When the VIX is in decline, but not at a low, while at the same time the SPX is right at an all time high, my general belief is that the SPX is going to go higher. We are in one of those scenarios right now. Take a look:
As many of you option traders know, the VIX closed below 15 for the first time in some time. While I think the VIX is getting pretty cheap, when we look at all of the equity vol indexes, some equities look even cheaper. There are few things to remember:
1. While a 15 VIX might seem low after the last 4 years, it would have been above normal between 2004 and 2007.
2. There are always things that are more cheaply priced.
3. There may be trades that are more expensive in relative terms.
The market got to a point today where it looked over the wall and could not take the plunge one way or the other. The S&P 500 E-mini could not hold onto the highs of the day and the VIX could not hold onto the lows of the day. So, how did it end up, and what did it mean?
As you can see from my illiterate scrawl on the chart, the VIX made a new near term low and promptly decided that was low enough. The rally in the VIX led the market to decline from its peak by about 30 min.
Many times early in ones options education traders will not quite know how to interpret the VIX and volatility. For instance, on a day like today, with the VIX down, many of my option mentoring students would think that volatility was down; it was not, in SPX options. Yes, VIX futures did sell off a touch, but the IV of SPX options themselves actually increased. We can tell this by looking at strike volatility rather than using a weighted index.
If we look at an OTM put, an OTM call, and the ATM call one can actually see the movement of IV today...up (each zig is a date):