“Learn Use Volatility to Put the Wind at Your Trade's Back”
Stocks ended their 4 day rally today after a lack of new promised stimulation from a Central Bank failed to materialize. Corporate earnings are getting a bit better into the cycle and even a whiff of inflation today kept a rally going this morning. For gosh sakes even YHOO posted rising revenue last night. Without the system shock of QE stocks could not sustain the climb from the bottom. Getting back to all-time highs will take a bit longer.
If you arent aware that the VIX is about half of itself from its peak last week, its time to take notice. What is interesting is how right the VIX really was at the time. leading into the sell off the VIX was creeping higher, closer to 16 or 17%, climed to above 20% pretty quickly and topped out last Tuesday when it settled lat about 26% or so.
I am not sure if the VIX is done moving. But the market was certainly interested in selling premium today. Traders came in, ahead of VIX expiration on Wednesday morning, and absolutely crushed October and November in the VIX futures. Nov futures outpaced the move one might expect from a future with 30 days to expire by a nice margin. The cash, which also got crushed was down 3.40, while the future was down about 1.80 points, more than the 50% move i might exect. At the same time, the curve dropped, like a gate back into contango:
The market has been moving at a clip of between 1-2% (today aside) for a few days now. If one looks at ATR today looks crazy as well in fact. Looking at GARCH from the last 10 days relative to SPX IV (similar to VIX) it appears that implied volatility is finally trading at some sort of premium to SPX.
Today was a crazy day, a super crazy day. The SPX touched down 10% and then POPPED off that level. At the same time the SPX went from down 55 points to only down 15. This happened in an extremely short period of time. The all out panic took place over a short period of time. Yet, one can see that cooler heads never really panicked the way the equity markets did. Take a look at the spread between VIX cash and the October future.
As we discussed on Friday, the VIX was still pointing toward more selling. Today, the same holds true. While the VIX is high, it is just now pricing in a 1.5% daily move for the next 30 days. That is less than the market has been moving the last few days though, and as the market falls, 30 ponits is becoming a bigger and bigger piece of the market pie, which should drive the VIX higher. Is the market in full capitulation? Probably not, a couple of major things point toward more selling:
The VIX curve. Desptie all the fear, the entire curve has not shifted. Traders are still pricing in a Christmas vol sell off.
Generally speaking, when the VIX is high, its a sale and when its low, its also a sale. However, there is one time where the expected pay out of selling VIX futures or options is not that great, when the VIX curve starts to do this:
Maybe it was the Europeans or maybe it was some jitters in China or Africa. The FOMC suddenly lost it zeal for raising rates. The economy here has been growing but not enough to satisfy our rate mandarins. Maybe it is the TWTR/FB world of instant gratification but it takes time to get off the QE band wagon. The Europeans are in the tougher boat of restructuring economies since they cannot borrow at the rate they used to so they can pay all the benefits. It does not look like Super Mario is going to finance that. Better to have slow or even growth from restructuring than souped up QE.