Traders have been increasingly eager to speculate on the future direction of interest rates. The volatility implied by options on 2-, 5-, 10-, and 30-year Treasury notes and bonds has lifted the Merrill Lynch MOVE Index above 110.
Contrary to what some may assume, an Outside Range Day is not a day at the driving range, but a technical analysis pattern described as when the price makes a high that is higher and the low that is lower than previous day.
The unusual number of announced M&A deals last week, coming right in the middle of the traditional summer vacation prompted one investment banker to say in a television interview that his "black car indicator" had risen to an all time high for August.
From a technical analysis perspective, the most important event occurred last Wednesday when the S&P 500 Index declined and then closed below the lower boundary of the potential rising wedge, thus setting off this bearish pattern.
The US Department of Education is in the process of changing the funding rules for these companies by requiring them to demonstrate that they are preparing students for actual jobs that give them the chance to replay the borrowed money. In this sector there are several stocks breaking down below their previous support levels.
After several weeks of "risk on" followed by "risk off" perhaps, it is time to begin looking for the possibility of a developing trading range. In this post, we review the technical condition of the equity market and update our indicators followed by a strategy suggestion considering the development of a trading range.
In addition to the VIX futures premium at 21.12, which is worthy of some new hedging positions, we suggest considering the possibility that a trading range is developing.
Once again, the pendulum swung back to the "risk on" position despite the uncertainties created by the unresolved macro debate over deficit cutting or more stimulus and coming changes to the financial system from "Fin Reg".
People are excited about tail risk. On the institutional side, banks and asset managers are packaging up complex, multi-asset hedging products and selling them to pension funds, endowments, and other natural longs. On the retail side, Barclays and others are getting great traction with products like VXX, VXZ, VXX options and now XXV.
Do traders expect more volatility in the longer term than they do in the short term? The one-month volatility (VIX) is almost always lower than the (three-month volatility (VXV), but sometimes it soars higher.
For the expected downside, or to hedge existing long positions, we think an interesting idea is to employ debit bear put spreads and credit call spreads.
In theory, a more volatile market in the next 30 days would justify higher options prices today, but does the VIX usually get it right in practice? Does today's VIX have any correlation with actual volatility over the next 30 days?
From "Risk Off" last week it was "Risk On" once again with an oversold rally taking the S&P 500 Index 5.4% higher. Now traders and investors want to know if the bottom has been made, or should we expect to see lower lows?
After a substantial rally that took the index past the overhead resistance at 1040.78 look for a minor trend change indicator for clues that this run could be about over.
Equity investors who want a broad-based hedge have essentially three vehicles from which to choose: equity index options (SPY, SPX, ES, etc.), VIX futures (or their ETF permutations), and VIX options.
The markets appear bewildered switching back and forth from "risk on" to "risk off" as if there is nothing in between. Now equities are in the risk off position as they accelerated to the downside creating a dramatic change in the technical condition.
Now the best plan is conditioned on the behavior of the SPX in the next few days. If a solid oversold rally develops then we suggest long call spread positions with defined risk in the previous strong sectors. Here are a few ideas.
The apathetic response to numerous fundamental developments last week could partly be attributed to seasonality, but a more likely explanation is the lack of clear vision for the global economy. Slower economic growth in the US and the many announced cuts in government spending in Europe are rekindling the inflation vs. deflation debate once again and creating hesitation.
The initial months of this year have been characterized by a low implied volatility (IV) environment in virtually all underlying securities. This milieu ended suddenly and abruptly on the recent "flash crash" and IV generally remains significantly elevated above its recent nadir.
In Roman mythology the god of beginnings and endings, Janus, is typically portrayed having two heads, each facing in opposite directions. His countenances are displayed in this manner so that he can observe the past as well as the future. The two types of option volatility, historical volatility and implied volatility, also reflect this dual perspective.
The S&P 500 Index broke out above the upper trendline defining the falling wedge technical pattern. Since the volume on the breakout appears to have been not as high as required for a valid breakout we are suspicious that it can meet its measuring objective above the April high.
Expecting an upside bias we set up our RT Spread Scanner and found some possible suggestions in the oil and gas sector that we are now calling event related due to the supply uncertainty from the problems in the Gulf of Mexico.
The CBOE Volatility Index (VIX) continues to make news. With the VIX hitting its one year high last month, it continues to buoy near 2010 highs. There is no shortage of media coverage on the VIX either, which may be prompting investors to try to profit off of it.
This oil spill is like a vortex. Ruins everything it touches. Coastline, jobs and companies, you name it. Like the spill itself, it casts a dark shadow over the market. What the spill is doing is affecting market sentiment and not in a good way. We can now actually measure market sentiment and create a number from it and combine that number with other market data.
Last Tuesdays' news that the Swiss National Bank's foreign currency reserves increased 80% in May resulting from the sale of Swiss francs and investing in Eurobonds, at a rate that appears to have exceed that of the European Central Bank, helped turn the tide of the very oversold euro. The result, a somewhat stronger euro also boosted equities and the economically sensitive commodities.
VIX skew can be a good indicator of the future. It can also fail in that regard. In actuality the VIX skew is just the sum of expectations for the future. And expectations of the market can be right or wrong.
To find a week with a comparable litany of bad news we need to go all the way back to the week ending September 22, 2008, a week that included the Lehman Brothers Chapter 11 petition of Bankruptcy and then after reducing their credit lines, Bank of America announced it would buy Merrill Lynch.
Direct from the Options Data Analysis and the Rankers & Scanners sections of IVolatility.com present the Best Calendar Spread based upon a differential between the implied volatility of the near term call compared to the implied volatility of the deferred month call.
Although European sovereign debt still occupies a large portion of the financial news space there is little doubt that the crude oil bellowing up from the bottom of the Gulf of Mexico is about to take top billing on the list of economic concerns. Like the inverse of decaying option time premium, every day the rupture spews more crude oil, the risk of permanent supply disruption due to political exasperation increases exponentially.
The updated weekly chart of the S&P 500 Index shows both a developing falling wedge outlined in green and the location of a potential right shoulder (RS) of a possible developing Head & Shoulders Top.
Volatility, one of the darlings of the options marketplace, has been all over the map this year. If you look at a sample of headlines from the first five months of 2010, you might think that either the market cannot make up its mind, or volatility has multiple, competing personalities.
In the recent weeks of market volatility, the hyper focus has been on global economies. In the short-term what's going to happen with Europe and the Euro Zone? Is the US immune? Is the "jobless" recovery going to sputter?
Over the last few weeks traders have experienced a sea change in the volatility environment of the market; we have gone from a milieu in which implied volatility (IV) was low and was perhaps establishing a new long term reality to the current state of accelerating IV in a wide range of underlyings.
Although the relative strength of the iShares Russell 2000 Index (IWM) over the SPDR S&P 500 Index (SPY) has diminished recently it still has the advantage for upside moves.
The SPX is now in the process of making a consolidation pattern in the form of a right triangle or perhaps a rising wedge during which implied volatility is likely to remain high. For those who want to trade the swings it appears a leg down to reversal point 3 is now underway.
Since our last market review, the character of the equity market has abruptly changed from a likely correction of the major uptrend to something of greater concern for the bulls.
In our May 3rd post, we began exploring the concept of having an edge, or advantage and its importance in trading. Today's post looks at the edge from the options perspective.
Many people are familiar with the leverage advantage of options however, some are not familiar with the disadvantages including time decay and how changing volatility influences options values.
The Euro shivers still resonate. No doubt. Usually for a day or two lately but they are very real and drive our equity and volatility markets to hair raising swings. The stock market does not seem to care about fundamentals or earnings anymore. Does any of the recent volatility moves make anything standout as a possible opportunity?
"May you live in interesting times" is an ancient Chinese curse. The fact that the last week has seen neck snapping and unprecedented changes in volatility, I think we qualify for living in what these philosophers would consider to be interesting times.
What happens to stock markets, which are now dominated by mathematical algorithms (algos), when they are all programmed to do the same thing? The likely answer is - no bids.
For those who may be looking for long ideas after the sell off here is a relative strength idea from the Options Data Analysis and Rankers & Scanners sections of Ivolatility.
Generally, there are two categories for the word edge; one describes a physical characteristic or location, such as a sharp edge or the edge of the cliff or canyon as shown above while the other is an analogy for advantage, such as having an edge or getting an edge. In this Digest, we explore both.
Many quarterly earnings reports are now coming every day and so far, most have beaten expectations.
Instead of trying to guess which companies will beat, our approach to earnings is to look for prospective volatility opportunities.
The news has been bad for GS in the short term and the system will take its course. In the meantime, let's analyze the news since last Friday and see how that has effected option volatility for GS.
Up until Goldman joined Greece on Friday, SPX was continuing higher with only the slightest indication of retesting support at the breakout high of 1150.45. Now all of that has changed.
After a long absence, there was some evidence last week that the "Bond Market Vigilantes" are indeed alive and once again expressing their anxiety and displeasure with the endless supply of sovereign debt offered, including US Treasury Bonds.
While waiting for the S&P 500 Index to complete a retest of the breakout there are some special situations worth considering. As the second quarter earnings reports begin, volatility is likely to begin increasing.
Now near the end of March 2010, with the help of modern day media, we are watching a modern day version of a Greek tragedy being played out as protests in the streets of Athens. Without the benefit of classic currency devaluation, it is hard to imagine a tranquil conclusion to this tragedy. We begin with a review of the markets followed by strategy comments and another hedging suggestion.
Live from the FIA Expo, Mark sits down with Scot Warren, MD of Equity Products and Index Services at the Chicago Mercantile Exchange. Scot dispels a number of rumors surrounding the CME's recent volatility licensing deal with the CBOE. Will we see VIX options and futures trading on the CME in the near future? Mark and Scot also explore the reasoning behind the CME's acquisition of the Dow Jones family of index products.
If you hold a position larger than a specified threshold in a futures or options contract that is regulated by the CFTC, your clearing firm must report it and classify your position as either commercial or non-commercial. Futures traders have been tracking these reports for years, but I'm not aware of any studies that analyze the history of VIX futures commitments...
Last week, I noted the very wide spread between short-term realized and implied volatilities. Although the selloff on Friday alleviated conditions slightly, [5] the spread is still large enough that traders inclined to be net sellers of options need not fear occasional daily increases in realized volatility.
My sense of the markets at this juncture is that elevated implied correlations are truthful, even oracular, with too-high index implied volatility representing not so much the jump risk with which the VIX is usually associated as the unwelcome prospect of individual equities tracking each other too closely.
The jump in volatility indexes noted in our previous report was met with a similar decline last week. The VIX could easily make a new 52-week low before 2009 is through. Gold implied volatility advanced sharply on Friday's price decline, with GVZ closing just shy of my 30% short-term target. The shift in the volatility skew in gold deserves attention: if traders continue to pay higher premiums for downside protection this week, that should be confirmation that the parabolic run in gold is over for the moment.
When equity index options consistently price in moves of more than 1.5% on two-thirds of trading days, Friday's trading range should not be a surprise, even if you believe equity volatility is significantly and consistently overpriced. We wouldn't expect longer-dated volatility futures contracts to move noticeably on last week's news, but even the December VIX contract only lifted slightly.
Equity index options are about as evenly priced as they've been in some time, but another continuation of the intermediate-term rally would mean more disappointment for option buyers, especially those who entered new positions in early November...
People seem to be about as loss-averse empirically as they are expected to be based on smaller studies. One reason this feature of human psychology is so important is that it is one probable cause of the persistence of the variance/volatility risk premium..
I wondered last week whether we would see a return to the reflation rally or were entering a new regime dominated by mean reversion. The price action last week counts in favor of both, as we reverted to the closing highs of the prior week; I expect a more definitive answer by November options expiration...
As I've noted on many occasions, the relationship between spot VIX and longer-dated VIX estimates has not "worked" as a directional indicator for at least several months. This looks like a genuine puzzle: the premium VIX futures traders are willing to pay and/or requiring in order to sell is too steep and has been too persistent to be dismissed as a phenomenon typical of the "wall of worry" that bull markets proverbially climb...
This article looks like a new attempt at establishing an old (but important) thesis, namely that there is a persistent volatility risk premium in options on equity index products (futures, ETFs, etc.). Most studies have attempted to define this premium in terms of option selling, and this is the first I can recall that looks at the negative returns from straddle purchases as additional evidence.
Many novice traders approach their option trading unsuccessfully due to their sole focus on a single dimension - price. With options, the price could move in the anticipated direction and the option premium could lose value due to time (second dimension) decay, due to change in the I.V. (the third dimension), or due to the combination of both time and I.V...
Successful option traders use volatility to their advantage on every single trade. While most seasoned option traders perform an implied historical volatility analysis, some traders don't go quite far enough. For a complete volatility study, traders must also look at the volatility skew...
Traders Talk Live Radio (which airs on AM 560 WIND in Chicago) recently featured www.TheOptionsInsider.com founder Mark S. Longo as a special guest. Mark discussed the impact of volatility on the options market. In addition, Mark & the hosts devoted an entire segment to the vagaries of volatility skew. Options Insider Radio listeners can find the complete broadcast here...
I've probably mentioned the term volatility in every article I've written about options trading. Everyone probably has an intuitive feel as to what volatility means. But how do we define volatility and how do we measure it?
I've had two great questions about the VIX from our viewers recently. What is the "Rule of 16" and how does a small increase in price impact the implied volatility of a far OTM option?
In this episode of Trader Interviews, host Tim Bourquin profiles www.TheOptionsInsider.com founder Mark Longo. Tim and Mark discuss the VIX, the election's impact on the financial market, options strategies for a volatile environment, floor trading vs. screen trading, options products for retail investors and much more...
There's been lots of talk about the CBOE Volatility Index (VIX) recently, and not just because it's stuck in the stratosphere. Some traders have raised controversy about whether it is an accurate reflection of volatility in the market place, especially after the October VIX futures expiration. They were upset about the disconnect between the VIX futures, which closed around 53, and the VIX calculation itself the next day. The futures were subject to a final settlement with that calculation and it came in at around 64. "Ouch!" if you were short. But, it's highly likely that those traders don't understand the VIX.
There have been calls for a volatility ETF based on the popular CBOE VIX. However, there are serious questions about how such a product would work and whether it is even a good idea in the first place...
Are you a volatility trader? Did your long volatility portfolio suffer despite a rally in the VIX? If so, then you may be one of the many options traders that has been fooled by Vega. Read on for a few simple steps to understanding this common, and infuriating, problem...
Are you a volatility trader? Did your long volatility portfolio suffer despite a rally in the VIX? If so, then you may be one of the many options traders that has been fooled by Vega. Read on for a few simple steps to understanding this common, and infuriating, problem...
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