VIX and More

Just a quick public service announcement to remind traders of VIX futures and options that the VIX weekly futures and options, which the CBOE launched earlier this year, will expire tomorrow instead of the usual Wednesday expiration.

The reason for the unusual Tuesday expiration is the Christmas holiday calendar. Keep in mind that VIX options expire 30 days before the underlying S&P 500 Index options on which they are based. As Christmas Day falls on a Friday this year, the SPX weekly options for the fourth week in December have their expiration moved up to Thursday, December 23, with the VIX weeklys for the fourth week in November moved up to tomorrow. Perhaps even more important, this means that this week’s VIX weeklys can last be traded today, so if you harbor any intentions about opening or closing a short-dated VIX weekly options (or futures) position tomorrow, be sure to make that happen today instead.

As an aside, as I see it, the VIX weeklys are the most important product launch in the volatility space in several years. The VIX weekly futures were launched in July, followed by a launch of the VIX weekly options in October. How popular are these products? Well, the VIX weekly options that expire tomorrow have an open interest of just under 100,000 contracts as I type this, as the graphic below demonstrates.

[source(s): Livevol Pro / CBOE]

The VIX weeklys have already become a staple of my client portfolios and are something every volatility investor should investigate. If you are one of those who has shied away from weeklys or is not comfortable trading options close to expiration, one book that I’m sure will give you something to think about along those lines is Jeff Augen’s, Trading Options at Expiration.

It should go without saying every options trader should have their own options calendar handy in order to help identify these calendar anomalies in advance. My personal favorites are as follows:

• CBOE Options Expiration Calendar
• OIC Options Expiration Calendar

Note that the links above are for 2016. For 2015 or for any other year, just edit the URL accordingly.

Finally, I have missed blogging on a regular basis and am committed to getting back into the game this week, ramping up my activity into the December FOMC meeting.

Related posts:

• Another Winner From Jeff Augen
• Trading Options Expiration Days
• The Convergence of VIX and VIX Futures at Expiration
• VIX March Futures and Options Expiration on Tuesday, Not Wednesday
• VIX Expiration Straddles
• VIX Expiration Condors
• Selling VIX Puts Pre-Expiration
• Weekly Options Coming on Strong
• A Favorite Trade: VXX Weeklys
• VIX Performance During the Options Expiration Cycle

Disclosure(s): short VIX at time of writing; the CBOE and Livevol are advertisers on VIX and More

Today I was once again a guest columnist at Barron’s, penning Low Volatility: How to Profit From a Quiet VIX for the venerable Barron’s options column, The Striking Price.  While this is my thirteenth turn as guest columnist, much to my surprise this is the firsts time that “VIX” has appeared in the title.  Since everyone seems to be talking about how low the VIX is, whether the VIX is broken, etc. I thought it would be an appropriate time to share some of my thoughts on the subject.

In the Barron’s article I make the point that while mean-reversion trades when the VIX spikes higher has been a viable strategy over the years, the mean reversion approach has not fared nearly as well when the VIX dives substantially below its long-term mean, which happens to be just a shade over 20.

As the chart below (monthly bars of the VIX) shows, most significant VIX spikes tend to be short-lived, but the VIX can remain well below the 20 level for multiple years in a row. Just look at 1994 – 1996 and 2004 – 2007 and think about the long-term viability of buying VIX calls or putting on a similar long volatility position during a period like this one, armed with the knowledge that eventually the VIX will have to revert to its historical mean.

[source(s): StockCharts.com]

In fact, there have already been two instances (1990 – 1994 and 2002 -2007) in which the VIX declined steadily for a period of at least four years. With the most recent peak volatility in August 2011, it is not unreasonable to think about the possibility of volatility continuing to decline or at least tread water through at least August 2015.

While the Barron’s article does not give my options trade idea a label, it is a ratio risk reversal that contemplates selling VIX June 14 puts and (perhaps) investing the proceeds in twice as many VIX June 17 calls.

I encourage everyone to read the original article at Barron’s, but for those who might not click through, I will include my closing paragraph below:

“No matter what your market outlook, however, do not make the mistake of thinking that the VIX is no longer relevant, and be careful when it comes to equating a low VIX with complacency. The VIX has closed below 13 some 964 times – and almost all of these instances have been in the middle of a bull market.”

Related posts:

• Was the VIX too Low in 2013? No…
• A VIX Risk Reversal
• Why VIX Puts Get Cheaper in More Distant Months
• Selling VIX Puts with the Help of a VIX Put Matrix
• Anchoring and a VIX of 20
• VIX Macro Cycles
• Was 2007 the Beginning of a New Era in Volatility?
• Shrinking VIX Macro Cycles
• VIX High or Low? It Depends…

A full list of my Barron’s contributions:

• Low Volatility: How to Profit from a Quiet VIX (May 22, 2014)
• Emerging Market Stocks: Have They Hit Bottom? (March 28, 2014)
• How to Spot Risk Early (July 16, 2013)
• How to Insure Your Stock Portfolio (April 18, 2013)
• The Case for Options Trading (January 2, 2013)
• Calm Down and Exploit Others’ Anxieties (November 14, 2012)
• How to Trade Options Around Volatile Events (July 10, 2012)
• Be Greedy While Others Are Fearful (May 3, 2012)
• Ways to Turn Volatility into an Asset Class (January 12, 2011)
• There’s Opportunity in Uncertainty (November 18, 2010)
• Will Market Volatility Return to Crisis Levels? (September 15, 2010)
• The Perils of Predicting Volatility (May 20, 2010)
• Take a Longer View on Volatility (July 2, 2009)

Disclosure(s): none

Earlier this month, I had the pleasure of attending the CBOE Risk Management Conference (RMC) in Bonita Springs, Florida. Now that the conference is over and the CBOE has posted most of the presentations, I thought I would take a little time and offer a retrospective look at some of the content that caught my attention.

Before I do that, I am compelled to tip my cap to Russell Rhoads, whose indefatigable and prolific efforts were responsible for capturing many of the details of the conference. Russell’s posts and those of Matt Moran made it possible for anyone to have a virtual front-row seat throughout the proceedings. Their efforts in conjunction with the RMC are archived at the CBOE Options Hub with the CBOERMC tag.

From my vantage point, I thought it particularly interesting that the two keynote speakers, Martin Zonis and Carl Tannenbaum, had such divergent views about the potential risks and rewards in the U.S. financial markets in the coming years. Zonis placed most of his attention on political risk and foreign policy matters and declared that the markets were “underestimating volatility in future years.” While Tannenbaum expressed concern about banks in Europe as well as credit and real estate in China, he had a much more sanguine view of the future of the U.S. economy and financial markets.

Among the other presentations, I was particularly interested to hear Maneesh Deshpande provide an overview of the players and strategies used in volatility products during the course of the evolution of the VIX product platform. Deshpande described the VIX futures as a mature market, with liquidity and supply having shifted from commercial to con-commercial traders. He also indicated that demand for VIX puts has stagnated, while new entrants are increasing the demand for VIX calls. All of this has influenced how the VIX spikes and mean reverts, as well as how the VIX futures term structure has evolved.

Another particularly interesting session involved Ed Tom and John-Mark Piampiano, who tackled the subject of the volatility of volatility, invoking the likes of VVIX as well as the third and fourth derivatives of SPX implied volatility. At every conference at least one session gives you things to mull over long after the speakers are done and for me, this was the session that hit the high notes. Ed Tom’s presentation has not yet been posted, but he started his talk by decomposing VIX risk premium into realized volatility plus skew plus kurtosis and went on from there.

Sheldon Natenberg and Trevor Mottl were tasked with the subject of evaluating the volatility surface: skew and term structure. Not surprisingly, they were up to the task, with Mottl focusing on the role of money and credit in shaping the volatility surface. He indicated that the increasing size of the Fed’s balance sheet has depressed volatility across the board over the course of the past few years and expects that as the Fed’s balance sheet normalizes, the change in non-financial debt will become the most important influence on equity market volatility going forward. Mottl attributed the steepness of the VIX futures term structure to the uncertainty related to the Fed’s ability to be successful with its quantitative easing program. He also traced fluctuations in the skew of volatility to expectations related to the Fed’s tapering plans.

Among the other presentations I sat in on were:

• a panel on volatility as an asset class (the consensus that volatility is more of a tool and in order to be thought of as an asset class needs to harvestable, allocatable and easier to benchmark; a separate thread was critical of the costs associated with traditional approaches to tail hedges)
• a discussion of trading volatility across asset classes (included an interesting set of metrics and trade ideas)
• a wide-ranging session on the design and trading of VIX and other volatility derivatives, which had a detailed explanation of the VIX settlement process as well as a discussion of VXST, which is expected to gain much more momentum when options on the index become available on April 10

Finally, I had an opportunity to sit down with Angela Miles of CBOE TV to offer my thoughts on the second day of RMC:

For those who may be interested, the 3rd Annual CBOE RMC will be held September 3-5, just south of Dublin, Ireland.  Since all of my ancestors trace their roots back to Ireland, I can’t imagine a better place to hear about the latest thinking in volatility and ponder the miracle of Guinness draught at the same time.

Related posts:

• CBOE Risk Management Conference Update
• Some Thoughts on the CBOE RMC
• Best VIX Conference of the Year? Try the CBOE RMC
• The Upcoming 2012 CBOE Risk Management Conference
• The VIX Summit, a.k.a. the CBOE Risk Management Conference
• Best VIX/Volatility/Risk Conference of 2013?

Disclosure(s): CBOE is an advertiser on VIX and More

Just a quick reminder for those who may not be aware of it that the VIX futures and options expiration for March falls on next Tuesday, March 18^th, not the typical Wednesday. This means that the VIX special opening quotation (SOQ) used to determine the March settlement price will be at the open on Tuesday and also the last trading day for the VIX March futures and options will be on Monday. With the speed at which things are developing in Ukraine and elsewhere, these 24 hours could turn out to be significant.

For those who are interested in a link to the VIX options expiration calendar, the CBOE maintains a 2014 options expiration calendar here, with the VIX expiration highlighted in a solid dark orange box. Note that I have a link to the CBOE options expiration calendar on the blog at the bottom of my VIX, Sentiment & Options section.

To review how the VIX expiration dates are determined, the VIX futures and options expire 30 days before the SPX monthly options expiration in the following month. These SPX options expirations are almost always on a Friday, therefore the VIX expiration is almost always on the Wednesday four weeks and two days prior to the SPX expiration. The complication factor for the VIX March 2014 expiration cycle is that on Friday, April 18, the CBOE is closed due to the Good Friday holiday, which pushes up the April SPX expiration to Thursday, April 17, with the result that the VIX March expiration is pushed up one day as well.

Last but not least, the VIX SOQ probably deserves a separate post in order to explain some of its unique characteristics, but it is worth noting that the VIX SOQ is not the price at which the VIX opens, but rather another separate calculation that takes place at the open.

Related posts:

• The Convergence of VIX and VIX Futures at Expiration
• VIX January Options as Short-Term Portfolio Protection
• Pricing of VIX August and September Calls
• Another Record Day in VIX Call Volume
• Selling VIX Puts Pre-Expiration
• A VIX Butterfly Play
• Follow-Up to “A VIX Butterfly Play”
• Lots of Premium Left on Last Day of Trading in VIX November Options
• SPX Options Carpet Bomb Pushes VIX SOQ to 63.04 (!)

Disclosure(s): CBOE is an advertiser on VIX and More

The monthly VIX futures and options expiration is a fascinating time from an options strategy perspective, as it marks the point in time in which VIX futures prices collide with the cash/spot VIX. Thanks to the VIX Special Opening Quotation (SOQ), that price collision is an inexact one, but for all practical purposes, the VIX front month futures and cash/spot index converge once every month, just after the open on a Wednesday thirty days before the standard monthly option in the S&P 500 Index options the following month.

To make things more interesting, the last day of trading for the front month VIX futures and options is the Tuesday session just prior to expiration.

All these product attributes make it difficult to navigate the complex waters of the VIX product platform just prior to expiration, but because the VIX is capable of such sudden sharp moves [see VIX All-Time Spike #11 (and a treasure trove of VIX spike data) for some details,] options prices have to include the possibility of a sudden VIX spike right up until the moment of expiration.

For these reasons, it is sometimes possible to sell VIX options for a surprisingly high premium right before expiration. In the graphic below, I have captured some data from the TD Ameritrade/thinkorswim platform that shows the prices of various VIX calls as of about 2:00 p.m. ET that expire tomorrow, with just more than two hours of trading left in these products. For comparison purposes, I have also included the September options for the same strikes, which will expire on September 18^th.  For the record, at the time of this snapshot, the VIX was at 14.48 and the August VX futures (now available on the TD Ameritrade/thinkorswim platform as ticker /VXQ3) were at 14.43.

Note that the TD Ameritrade/thinkorswim platform includes information on the implied volatility calculated for these VIX calls as well as the estimated probability that these will expire out-of-the-money on September 18^th. Theoretically at least, the VIX August 25 calls have a more than 1% of expiring in-the-money at tomorrow’s open, while there is more than a 5% chance that the VIX September 25 calls will expire in-the-money. With an implied volatility of 139%, the VIX September 25 calls are currently bid-ask at 0.25 – 0.30.

I am not recommending selling VIX calls just prior to expiration and I certainly would want anyone who is interested in these type of trades to start out with defined risk trades (e.g., bear call spreads) before considering trades with unlimited risk...but the possible trading opportunities are fascinating, to me at least.

[source(s): TD Ameritrade/thinkorswim]

For those interested in additional background on the VIX expiration and some potential trade ideas, the posts below should provide a good jumping off point.

Related posts:

• VIX All-Time Spike #11 (and a treasure trove of VIX spike data)
• Selling VIX Puts Pre-Expiration
• VIX Expiration Straddles
• VIX Expiration Condors
• A VIX Butterfly Play
• Follow Up to “A VIX Butterfly Play”
• The Convergence of VIX and VIX Futures at Expiration
• SPX Options Carpet Bomb Pushes VIX SOQ to 63.04 (!)
• Another Winner from Jeff Augen

Disclosure(s): neutral position in VIX via options at time of writing

When I recently assembled Top Posts of 2013 (Through First Half of Year), several themes jumped off the page. The top four posts of the year summarize what many investors have been worrying about this year:

1. The Low Volatility Story in Pictures
2. Four Years of SPX Pullbacks in One Plot
3. VIX ETP Performance in 2012
4. All-Time VIX Spike #11 (and a treasure trove of VIX spike data)

The issues are related to pullbacks in stocks, the VIX spikes associated with them, how to minimize portfolio volatility when these types of events happen and what the implications are for various VIX exchange-traded products.

With that backdrop and a stock market that has been looking fatigued while it has meandered sideways for the past month, quite a few investors are thinking about how to hedge a portfolio that has a long-equity bias. In the graphic below, I capture the recent performance of a number of ETPs which may be suitable for hedging that type of portfolio.

[source(s): StockCharts.com]

Interestingly, the performance of these securities appears to fall into three distinct groups.

The top group has two ETPs:

• SPY (black line), included largely for reference purposes
• Direxion S&P 500 RC Volatility Response Shares (VSPY), which employs a market timing mechanism that dynamically allocates between stocks and bonds according to measures of market volatility (blue-green line)

The second group contains the core of the VIX-based dynamic hedging products:

• First Trust CBOE S&P 500 Tail Hedge Fund ETF (VIXH), which is essentially a portfolio consisting of 99-100% of SPY, augmented by a dynamic allocation of 0-1% of VIX options (light green line)
• Barclays ETN+ S&P VEQTOR ETN (VQT), which has a dynamic allocation of VIX futures that fluctuates based on realized volatility and the trend in implied volatility (red line)
• PowerShares S&P 500Downside Hedged Portfolio (PHDG), like VQT, has a dynamic allocation of VIX futures and is based on the S&P 500 Dynamic VEQTOR Index (dark purple line)

The bottom group includes two performers:

• UBS ETRACS Daily Long-Short VIX ETN (XVIX), which is equivalent to a fixed allocation of a 100% long position in VXZ, offset by a 50% short position in VXX. I have included XVIX (aqua blue line) here largely to show how closely the performance corresponds to that of XVZ
• iPath S&P 500 Dynamic VIX ETN (XVZ), utilizes the slope of the VIX:VXV ratio (SPX 30-day implied volatility to SPX 93-day implied volatility) to determine the dynamic allocation to short-term and medium-term VIX futures. In this case, the allocation to short-term VIX futures (think VXX) can be either long or short, while the allocation to medium-term VIX futures will always be long, though it is variable (fuchsia line)

Keep in mind that the most aggressive hedges are almost always the ones that underperform the most in bullish periods. If you want a very different look at how some of these products perform when stocks decline sharply, check out Performance of VIX ETP Hedges in Current Selloff.

The links below provide some background information on some of these products as well as performance data and should serve as excellent starting points for more comprehensive research.

Related posts:

• VIX ETP Performance in 2012
• Dynamic VIX ETPS as Long-Term Hedges
• Performance of Volatility-Hedged ETPs
• Performance of VIX ETP Hedges in Current Selloff
• Comparing SPLV and VQT
• Three New Risk Control ETFs from Direxion
• Cheating with Partial Hedges
• How to Insure Your Stock Portfolio (Barron’s)
• Why Not Point Hedges?
• Investing with a Target Volatility Approach

Disclosure(s): long VQT and short VXX at time of writing

Exactly three weeks ago today, I thought I would break some news on an intraday basis with a post that I titled, Record VIX Options Volume and Large Purchases of VIX Calls. As it turns out, by the time the day’s total volume was tallied, February 26^th turned out to be an all-time record for VIX options volume in general and VIX calls in particular.

The events of three weeks ago now look a little less impressive in light of today’s new record in VIX call volume. Truth be told, VIX options seem to be attracting the attention of a new group of investors. In fact, during the CBOE Risk Management Conference earlier this month, there was a great deal of speculation surrounding who some of the new players in the VIX space might be that are responsible for the new growth in VIX futures and VIX options that appears to be independent of the volume driven by VIX ETPs.  [Hedge funds, proprietary trading firms, commodity trading pools/advisors, insurance companies, bond traders, FX traders and others were among the names that were bandied about…]

As is typically the case with the VIX, call volume outpaced put volume by a substantial margin. Today the call to put ratio was about 2.2 to 1, slightly higher than the average of 1.9 to 1. That being said, put buyers appeared to be a little more aggressive than call buyers, with 42% of all puts bought on the ask, as opposed to 30% of the calls, according to data provided by LivevolPro.

Investors are always looking for an interpretive overlay for these VIX options transactions. Frankly, on the day before the March VIX expiration, a great deal of the options activity is the result of large investors closing out March positions or attempting to game the special opening quotation (VIX SOQ) from tomorrow’s open that establishes the settlement price for VIX options and futures.  As a result of that low signal to noise ratio, the day prior to expiration is generally not a productive time for reading options entrails, though there will no doubt be some who are hell-bent on some sort of options divination regardless of where we are in the VIX expiration cycle.  For today at least, I would suggest that the links below might bear more fruit. 

Related posts:

• Record VIX Options Volume and Large Purchases of VIX Calls
• A VIX Risk Reversal
• VIX Puts Looking Attractive
• Selling VIX Puts Pre-Expiration
• A VIX Butterfly Play
• Follow-Up To “A VIX Butterfly Play”
• SPX Options Carpet Bomb Takes VIX SOQ to 63.04(!)
• Taking Profits in VIX Options (and ETPs)
• VIX Implied Volatility Exceeds 2008 Crisis Levels

[source(s): LivevolPro.com]

Disclosure(s): Livevol and the CBOE are advertisers on VIX and More

The 29^th Annual CBOE Risk Management Conference (RMC), wound down yesterday, proving that while Chicagoans and New Yorkers were happy enough just to escape the snow, there were some excellent business reasons for making the trip to southern California.

What I like to call the “VIX Summit” is no doubt the best place for VIXophiles to congregate, get acquainted, and exchange ideas related to a subject that tends to be arcane and poorly understood in most quarters, yet is increasingly embraced by a wide variety of practitioners. Nancy Davis of AllianceBernstein probably summarized best what is happening in the volatility space when she identified three trends that are driving institutional use of options:

1. New entrants
2. Cross-asset class opportunities
3. Structural differences

In terms of new entrants, the VIX product space is seeing a wide range of new institutional interest from hedge funds and proprietary trading firms to CTAs (commodity trading advisors), insurance companies and other firms, many with an international flavor. One of the common themes is the search for yield enhancement strategies. A lot of this activity can explain the recent surge in volume in VIX futures and VIX options. Whereas VIX ETPs had been driving volumes in VIX futures in the past, now growth is being driven by the participation by a broad range of new institutional players, some of whom are “curve hopping” from Treasuries to the VIX and many of whom are motivated by the lack of compelling alternatives to enhancing yield.

In these types of events there is always one presentation that catches you by surprise and gives you a lot of ideas to ponder that had not necessarily been on your radar. For me that presentation came from John Coates, the author of The Hour Between Dog and Wolf: Risk Taking, Gut Feelings and the Biology of Boom and Bust. In a wide-ranging talk, Coates has some compelling observations on physiological systems and how these are intertwined with everything from pleasure and addiction to expectations, uncertainty and risk assessment. Frankly, even if the subject of trading was not directly incorporated into this presentation, this talk still probably would have left me with more to chew on than the other presentations.

In the U.S., the RMC alternates between Florida in even years and southern California in odd years and is typically held during the last week of February or the first week in March. Last year a CBOE RMC – Europe conference was added in Ireland. The success of that conference has translated into a repeat performance that is scheduled for September 30 – October 2, 2013 at the Penha Longa Hotel in Sintra, Portugal, just outside of Lisbon. As a port fan who has never been to Portugal, I can certainly envision a trip to Portugal in September in addition to Florida next year.

Last but not least, thanks to all those I the pleasure of meeting this week.

[photo: near Big Sur, California]

Related posts:

• Best VIX Conference of the Year? Try the CBOE RMC
• The Upcoming 2012 CBOE Risk Management Conference
• The VIX Summit, a.k.a. the CBOE Risk Management Conference

Disclosure(s): the CBOE is an advertiser on VIX and More; VIX and More is a sponsor of the CBOE Risk Management Conference

With about a half hour left in today’s trading session, purchases of VIX options are unusually high – much higher than yesterday. As I type this, over 855,000 VIX calls have been traded, with today likely to see the highest VIX call volume since the August 2011 market panic. Data from LivevolPro indicate that 28% of VIX call transactions are being bought on the ask, versus 16% sold at the bid, reflecting a lack of price sensitivity on the part of the buyers of VIX calls, who are the driving force behind these transactions. All told, a record 1.3 million VIX options contracts have been traded, breaking the old record of 1.22 million from September 11, 2012.

Note also that while the VIX’s implied volatility has been on the rise as of late, at its current level it is in the middle of its 2012 range.

The equities market may feel more orderly and composed today, but in the options market, there are signs of increasing anxiety and concern.

[source(s): LivevolPro.com]

Related posts:

• A VIX Risk Reversal
• VIX Puts Looking Attractive
• Taking Profits in VIX Options (and ETPs)
• VIX Implied Volatility Exceeds 2008 Crisis Levels

Investors who have been trading the VIX futures, VIX options and VIX exchange-traded products in 2012 have no doubt observed that there has been a wide gulf between the volatility predicted by the VIX front month futures and the back month futures. How wide? Well the graphic below shows the average (mean) normalized term structure for each year since the VIX futures were launched, back in 2004. In normalizing the data, I have set the average front month VIX futures contract to 100 and have expressed the averages of the second through seven months as multiples of the front month.

[Note that while the VIX futures were launched in 2004, consecutive VIX futures contracts for the first six months were not available until October 2006, hence the dotted lines for these years to reflect the erratic nature of the data. Also, I have included the seventh month contract in the calculations because this month is critical to the calculations of a number of VIX ETPs, including VXZ, VIXM, ZIV, etc.]

[source(s): CBOE]

For anyone who has followed the VIX futures closely, it should come as no surprise that 2008 (solid red line) is the only year in which the full VIX futures term structure was in backwardation (front months higher than back months) in aggregate. During 2009 (solid orange line), the term structure transitioned from backwardation to contango (front months higher than back months) and for the most of the balance of its life, the VIX futures term structure has remained in contango.

The graphic shows no discernible trend of extreme contango evolving over the past few years. While 2010 is the year with the second highest degree of contango across the full term structure, contango was decidedly muted during 2011. In fact, 2011 saw the longest continuous stretch of backwardation during the height of the European sovereign debt crisis.

Looking closely at the differences between 2012 and 2010, there is very little difference in contango out to the second month. The normalized term structure curves begin to diverge substantially only after the third month, where the 2010 term structure begins to flatten and the 2012 term structure continues an almost linear ascent. In fact the most distinctive feature of the 2012 term structure is the absence of any significant flattening in the VIX futures curve in months four, five, six and seven. This is part of the reason that while XIV is up 165% for the year, ZIV has managed a gain of 72%.

As this series continues, I will examine some of the possible causes of the recent persistent steep contango in the VIX futures term structure, particularly in some of the back months.

Posts in current series on VIX futures:

• Violent Disagreement Across VIX Futures
• Ratio of VIX to Realized Volatility Higher Than Any Year Since 1996

Related posts:

• Crazy VIX:VXV Ratio Chart
• Tracking the Fall in VIX Futures
• Third Steepest First-Second Month VIX Futures Contango Ever
• Monitoring VIX Futures and Their Impact on VIX ETPs
• ZIV Undeservedly Neglected
• VIX Exchange-Traded Products: The Year in Review, 2011
• VXX Calculations, VIX Futures and Time Decay
• Availability Bias and Disaster Imprinting
• VIX Data to Support Availability Bias and Disaster Imprinting Hypothesis
• Thinking About Volatility (First in a Series)

Disclosure(s): long XIV and ZIV at time of writing

Something strange has happened to the VIX futures in 2012: for the first time in their history, the VIX futures persist in being in violent disagreement with each other. Prior to 2012, for instance, the average difference between the front month and seventh month VIX futures was about 16%. This year that number has surged to more than 38%.

The VIX futures term structure has been in extreme contango (back months higher than front months) for the better part of 2012, with 17 days in which the contango across the full VIX futures curve has exceeded the all-time record that stood prior to 2012. It is almost as if the idea of a flat VIX futures term structure curve is passé and traders are convinced that the short-term volatility picture is perpetually an aberration that bears little resemblance to longer-term volatility expectations. Can these two differing perspectives of the future of volatility meaningfully coexist? If not, which view is likely to be wrong?

In a series of upcoming posts, I will put the issue of a VIX futures term structure in disarray under the microscope and discuss issues such as the huge gap between implied volatility and realized volatility, disaster imprinting and the role of the recent financial crisis in shaping future volatility expectations, looming issues such as the European sovereign debt crisis, the fiscal cliff, the potential for a hard landing in China, etc.

Ultimately I will attempt to answer the question of whether the back month VIX futures should be trading at levels that are 45-90% higher than the front month VIX futures, as has been the case for the past two months. I will also look at some of the implications for trading VIX futures, VIX options and VIX exchange-traded products.

In the interim, some of the links below might provide some useful background and context.

Related posts:

• Crazy VIX:VXV Ratio Chart
• Tracking the Fall in VIX Futures
• Third Steepest First-Second Month VIX Futures Contango Ever
• Monitoring VIX Futures and Their Impact on VIX ETPs
• ZIV Undeservedly Neglected
• VIX Exchange-Traded Products: The Year in Review, 2011
• VXX Calculations, VIX Futures and Time Decay
• Why VXX Is Not a Good Short-Term or Long-Term Play
• VIX Futures Brokers
• Availability Bias and Disaster Imprinting
• VIX Data to Support Availability Bias and Disaster Imprinting Hypothesis
• Be Greedy When Others Are Fearful (Barron’s)

Disclosure(s): none

Two thirds of 2012 passed before we saw the first new VIX-based exchange-traded product and it turned out to be an interesting one: the First Trust CBOE S&P 500 Tail Hedge Fund ETF (VIXH), which was introduced at the end of August. VIXH is essentially a portfolio consisting of 99-100% of SPY, augmented by a dynamic allocation of 0-1% of VIX options, with the amount of options determined by the level of the VIX at the beginning of each VIX expiration cycle. This is the first VIX-based ETP to included VIX options among its holdings and it is notable that this product bucks the recent trend and is an ETF instead of an ETN. There are other features of VIXH worth discussing and I will discuss these in future posts.

As the VIX ETP product space expands a bit, it also contracts a great deal, as UBS has elected to close 12 of its ETRACS ETNs, effective tomorrow, September 11, 2012. These UBS products failed to gain sufficient volume and assets to make these viable over the long haul, but when AAVX retires, it will do so with the best VIX ETP track record of all-time. This product was launched on September 8, 2011 and is up about 120% in the year plus since it was launched. [See ETRACS Volatility ETPs for the full list of ETPs that will be closed.]

The graphic below is my periodic update of the VIX exchange-traded products (ETP) landscape, using the y-axis to denote leverage and the x-axis to indicate target maturity. In addition to the explanatory notes in the key at the bottom, it is worth noting that I use font color to distinguish between ETFs (black) and ETNs (blue). Also, I have used a parenthetical one letter code to identify the issuer: B = Barclays; C = Citibank; F = First Trust; P = ProShares; U = UBS; and V = VelocityShares.

[As an aside, regular posting should resume again this week…]

Related posts:

• VIX ETP Returns for Q1 2012
• VIX Exchange-Traded Products: The Year in Review, 2011
• VXX, VXZ, XIV and ZIV During Eleven Months of a Sideways VIX
• A Monthly Comparison of VXX and VXZ
• Options on UVXY and SVXY Open Up New VIX ETP Trading Approaches
• Dynamic VIX ETPs as Long-Term Hedges
• ETRACS Volatility ETPs
• Four Key Drivers of the Price of TVIX
• Will TVIX Go to Zero?

Disclosure(s): long VIX at time of writing

With the VIX at about 14.50 as I type this and a large group of investors convinced that stocks are overbought and/or not properly discounting global macro risk, many are wondering just how to translate their beliefs into an effective trading strategy.

For those who think a long volatility trade is the answer, there is the issue of the significant contango headwinds, where a negative roll yield will pummel net asset values on VIX options and VIX exchange-traded products as a part of the daily rebalancing process, while VIX futures are subjected to a similar decay that reminds me a little bit of a dying helium balloon. Long story short: there is a huge daily penalty being assessed just for holding these long positions.

There are ways to minimize the effect of negative roll yield and typically one of the best of these is to work with positions that focus on the more distant months of the VIX futures term structure. This is generally why VXZ outperforms VXX over an extended period. Unfortunately for aficionados of VXZ, the negative roll yield between the fourth and seventh month VIX futures (VXZ buys the seventh month and sells the front month each day) hit a new record on Monday and continues at near record levels.

So what is a long volatility trader to do?

One trade that I somehow have never managed to highlight in my 5 ½ of writing about the VIX is a VIX risk reversal. A risk reversal is essentially a synthetic long position in which a trader uses options to create a position that is similar to owning the underlying, but typically ties up less capital in the process. In the case of a risk reversal, this means selling out-of-the-money puts and buying out-of-the-money calls. In many instances, the sale of the put options will finance 100% of the cost of the calls.

While the VIX is currently trading at 14.50, keep in mind that the best proxy for the price of the underlying for VIX options is the VIX futures for the corresponding month. So, with the September VIX futures at 18.95 at the moment, one could sell the September 18.00 puts for 1.50 and buy the September 24 calls for 1.05, pocketing the 0.45 differential. A more conservative trader might look to sell the VIX September 16 puts for 0.55 and use the proceeds to pick up a September 30 call for 0.55 or to defray some of the costs of the purchase of a more expensive call, such as the September 24 (priced at 1.05) mentioned above.

There are ways to turn this idea into a more aggressive trade as well. One approach is to morph a risk reversal into a leveraged trade in which more calls units are purchased than put units are sold. An example of this approach might involve selling the September 19 puts (which are currently at-the-money) for 2.15 and using the proceeds to purchase two contracts of the September 24 calls for 1.05 each.

A risk reversal also goes by other names, notably a long combination (or long combo) and, despite the name, is a high-risk trade that is vulnerable to the ravages of time decay. This trade is not for everyone, but can be a good way to generate significant long exposure with a minimal outlay of funds and sometimes no outlay of funds at all.

Related posts:

• Crazy VIX:VXV Ratio Chart
• Options on UVXY and SVXY Open Up New VIX ETP Trading Approaches
• Performance of Volatility-Hedged ETPs
• Dynamic VIX ETPs as Long-Term Hedges
• New and Noteworthy: VIXcentral.com
• Third Steepest Front-Second Month VIX Futures Contango Ever
• VXX Calculations, VIX Futures and Time Decay
• Why VXX Is Not a Good Short-Term or Long-Term Play
• A Monthly Comparison of VXX and VXZ
• Ten Things Everyone Should Know About the VIX

Disclosure(s): long VIX at time of writing

While this week’s news cycle has been Spain, Spain, Italy and Spain so far (reminiscent of an old Monty Python skit, but I digress), it is easy to forget for a moment or so that Greece is holding another round of elections on Sunday.

As Greek law prohibits polling or publishing poll results in the 14 days leading up to an election, we do not know how voter sentiment about the bailout and remaining in the euro may be ebbing or flowing. Greek voters have certainly a great deal to think about, some of which may have been complicated by the positioning of Syriza’s leader, Alexis Tsipras, who insists that it is possible to repudiate the bailout agreement, start afresh with a new plan that is based on stimulating economic growth and job creation – yet never have to leave the euro zone in the process.

So just how will the Greek elections influence the future of the euro?

Without polls, the Intrade contract that specifies “Any country currently using the Euro to announce intention to drop it before midnight ET 31 Dec 2012” now becomes an even more valuable informational resource. The problem is that in spite of a fair amount of activity, the price of the contract has remained essentially unchanged for the last month, hugging the 40 level (see chart below), which means that participants continue believe that the chance of a Greek exit (I refuse to say ‘Grexit’) by the end of the year is about 40%.

By Monday we will have a much more information, but once again, the process of forming a coalition government may prove to be troublesome…or worse.

For those looking for hedges against some panic in the financial markets next week, keep in mind that VIX options do not expire this week, but next Wednesday, June 20^th. As such, VIX calls may prove to be an appropriate hedge against at least short-term post-election anxiety. For those looking for volatility hedges on a week-to-week rather than monthly basis, it might be helpful to investigate VXX weekly options (A Favorite Trade: VXX Weeklys) as well. Last but not least, a reader favorite is a thought piece on the process of constructing hedges is Cheating with Partial Hedges.

Related posts:

• Handicapping the Chances of Greece Dropping the Euro
• The Hollande Discount
• A Favorite Trade: VXX Weeklys
• Cheating with Partial Hedges
• Expectations, Surprises and Fear in 2011
• Chart of the Week: European Stocks Holding Up Well
• Recent Performance Divergence in European ETFs
• Where and When Will the Euro Bottom?
• Greece, Spain and the Pulse of European Anxiety
• Are You Watching Greece?
• Intrade Prediction Markets as a Sentiment Indicator

[source(s): Intrade.com]

Disclosure(s): short VXX at time of writing

With the huge contango in the VIX futures term structure at the moment, anyone who is buying VIX options or the VIX exchange-traded products (ETPs) right now is having to pay for that contango in order to have the opportunity to capitalize on increasing volatility. With the contango-based negative roll yield currently running at 15% per month, this means the cost of a volatility hedge for long equity positions is extremely expensive in the current market.

Fortunately, investors do have some alternatives that have a different type of appeal.

There are two VIX ETPs, VQT and XVZ, which attempt to minimize the impact of the negative roll yield by using a market timing mechanism that dynamically adjusts the long volatility exposure. In more volatile markets, the exposure increases; in less volatile markets, the long volatility exposure is either very low (in the case of VQT) or can even flip to a small net short position (in the case of XVZ).

VQT is more of a portfolio replacement strategy, while XVZ is more of a portfolio augmentation strategy. Specifically, VQT has long SPY exposure that ranges from 60% to 97.5% of its portfolio, with the balance (2.5% - 40%) allocated to a long position in the VIX short-term futures (think VXX). The links below will provide more details.

XVZ, on the other hand, does not hold any long equity component, only short-term (again, think VXX) and mid-term (think VXZ) VIX futures. The twist here is that while the mid-term VIX futures component can range from 50-100% of the portfolio, the short-term component can be as high as 50%, but as low as negative 30%. So…under certain circumstances (e.g., a very steep VIX futures term structure, like the one we are currently experiencing), the portfolio will consist of the equivalent of a 30% short position in VXX and a 70% long position in VXZ. On balance, that type of portfolio should be very close to volatility neutral and in some cases even have a slight short volatility bias.

Since XVZ was only launched on August 18, 2011 (VQT dates back to September 2010), I have chosen a graphic that shows the relative performance of the SPX (red line), VQT (blue line) and XVZ (green line) from the launch of XVZ to the present. Note that with its long exposure, VQT is better able to take advantage of a low volatility slow bull market. XVZ, on the other hand, is generally close to flat in a low volatility bull market, but should the VIX spike sharply higher, XVZ will likely do a better job of capitalizing on the volatility spike.

As investors ponder the fatigued bulls and inevitable pullback sometime in the near future, certainly VQT and XVZ warrant a more detailed investigation, along with some of the non-volatility ETPs that are meant to reduce risk and hedge against a downturn, such as VSPY, SPLV, and others.

Related posts:

• Comparing SPLV and VQT
• Three New Risk Control ETFs from Direxion
• High and Low Volatility ETPs
• An Updated Field Guide to VIX ETPs
• VIX Exchange-Traded Products: The Year in Review, 2011
• Direxion and S&P Bring Dynamic Volatility Hedging to ETFs with VEQTOR
• Barclays VEQTOR ETN (VQT) Begins Trading
• The Case for VQT

[source(s): StockCharts.com]

Disclosure(s): long XVZ and short VXX at time of writing

Options volume in VXX (iPath S&P 500 VIX Short-Term Futures ETN) surged to their second highest level ever on Friday, with 344,777 contracts trading and put volume (56%) outpacing call volume (44%) by an unusually high margin.

The chart below shows the options activity in VXX going back to the beginning of August 2011. Note that record options volume in VXX dates from August 5^th and occurred just before VXX spiked from 30 to the upper 50s. On that day and most of the other high volume days in VXX options the calls (green vertical bars on bottom portion of chart) saw more action than the puts (red bars), as investors were most likely betting on an increase in volatility – or hedging against that potential scenario.

Friday’s volume was unusual, just as it was on January 26^th, in that put volume dominated. On balance, traders generally buy and sell more VXX calls than puts. In today’s session, so far the volumes in VXX options are much lower than they were on Friday and the activity in puts and calls is balanced and relatively calm.

This is not to say that VXX options investors are particularly prescient and should not be considered contrarian sentiment indicators. Instead, I am merely suggesting that there was no panic in Friday’s VIX spike.

In fact, the rumor I heard (via a commenter on the blog) that makes the most sense is that someone who had a position consisting of VIX futures, SPX straddles and the TVIX ETP (and supposedly about 90% of the open interest in TVIX) had their position liquidated by a clearing house – and some of the banks that got wind of what was going on were able to front run that move. Take it all with a grain of salt, but that kind of scenario is a good fit for the prints I saw and the facts as we know them.

Finally, keep in mind that the February VIX futures and options expire at Wednesday’s open. February VIX options are last traded tomorrow, while the February VIX futures are last traded in Wednesday’s pre-market session, from 8:00 – 9:15 a.m. ET.

Related posts:

• Volatility Becomes Unhinged on Friday
• Implications of a Positively Correlated SPX and VIX
• TVIX Finally Getting Its Due as Day Trading Rocket Fuel
• A Monthly Comparison of VXX and VXZ
• VXX Celebrates Third Birthday
• VIX Exchange-Traded Products: The Year in Review, 2011
• VXX Calculations, VIX Futures and Time Decay
• Why VXX Is Not a Good Short-Term or Long-Term Play
• The VIX-VXX Minotaur Trade
• Chart of the Week: VXX vs. VIX
• The Sideways Play [SPX Short Straddle]
• Position Management for SPX Short Straddle
• Managing Risk with a Short VXX Position
• A Conceptual Framework for Volatility Events

[source(s): LivevolPro.com]

Disclosure(s): short VXX and TVIX at time of writing; Livevol is an advertiser on VIX and More

Two hours into today’s session, the trading idea I mentioned yesterday, going long VIX puts, is doing quite well. The VIX Dec 27.50s are up more than 50% and the Dec 30s puts have advanced about 45%.

One question that I believe is much trickier with VIX options than options for most other securities is when and how to take profits. A large reason why taking profits in VIX options has an extra layer of complexity and difficulty is due to the mean reversion tendencies of volatility in general and the VIX in particular.

Another potential complicating factor regarding the management of VIX options positions has to do with their underlying. I hope that by now readers of this blog have had it drummed into their head that the VIX futures are the best proxy for the underlying in VIX options, not the cash VIX or VIX index, which is the VIX that is most often quoted in the media. Anyone holding positions in VIX options – and VIX ETPs for that matter – should be monitoring the VIX futures.

Looking at the changes in the first two hours of trading, one can see the typical pattern in which the front month (December) VIX futures (-6.3%) are moving about 80% as much as the cash VIX (-7.9%), with the second month (January) futures (-4.4%) moving about 56% of the cash VIX. This is right in line with historical norms. For an additional data point, VXX, which is a blend of front month and second month VIX futures, is down about 4.7%, which makes sense in that hold a disproportionate amount of front month futures at this point in the options expiration cycle.

So what does this all mean for taking profits in VIX options?

First, I cannot overstate how important it is to watch the VIX futures and understand how they move in relation to the cash VIX.

Second, because the VIX has a tendency to mean revert and thus often reverse recent sharp moves in either direction, it is important to take at least partial profits when one is the beneficiary of a significant favorable move in volatility. I like to take profits in 25% or 50% of my position, for instance, if my VIX options appreciate by 50%.

Third, keep in mind that the long VIX puts mentioned above are still out of the money and have no intrinsic value. As a result, they are subject to significant time decay (theta) each day and therefore will lose value if there are no additional favorable moves in volatility.

The bottom line is that harvesting VIX profits can be a challenging task and should be thought of as part art and part science. One only has to look at the many steeple-shaped VIX spikes to appreciate just how fleeting large profit opportunities in VIX options can be.

Besides, who knows what the next rumor out of Europe will be and how much the masses will panic or unpanic.

Related posts:

• VIX Puts Looking Attractive
• VIX Under 30 Five Days in a Row?
• Forces Acting on the VIX
• A Conceptual Framework for Volatility Events
• The Convergence of VIX and VIX Futures at Expiration

[source: LivevolPro.com]

Disclosure(s): short VXX at time of writing; Livevol is an advertiser on VIX and More

A lot can happen to the financial markets in the course of the next day or so and by my unofficial reckoning, quite a few of those are not just scary, but could have a 2008 flavor to them.

With the VIX at 30.60, implied volatility certainly is high, but not as high as it has been in recent months. This sounds like it may be a good time to buy some VIX calls, but I have a contrarian thought. VIX puts are relatively overlooked right now. The ask for the VIX Dec 27.50s is 1.00 and for the Dec 30s it is 2.30. Should we see a post-summit volatility crush, then even with some of those bearish scenarios, it is possible that the VIX will be declining as the anxiety over event volatility is behind us.

I like to say that the best time to buy VIX calls as portfolio protection is when the VIX is cheap, not when you think you need it. The corollary to this is that a good time to buy VIX puts is when everyone else is snapping up the calls at inflated prices.

Keep in mind that VIX options have their own options cycle. This month they expire on Wednesday the 21^st and the last time they can be traded is on Tuesday the 20^th.

Related posts:

• VIX Under 30 Five Days in a Row?
• Forces Acting on the VIX
• A Conceptual Framework for Volatility Events
• The Convergence of VIX and VIX Futures at Expiration

[source: LivevolPro.com]

Disclosure(s): Livevol is an advertiser on VIX and More

VIX futures and options expire 30 days prior to the expiration of options in the S&P 500 index for the following month. With the September SPX options expiration set for September 16^th, this means that August VIX options will expire on next Wednesday, August 17^th.

Students of the VIX (and there seem to be many when the VIX spikes over 40) should all know that over the course of their life, VIX options are not priced off of the VIX index. Instead, the best approximations for the appropriate underlying for VIX options are the corresponding VIX futures. The one caveat is that at expiration, the VIX index and VIX futures must converge on a single price for the VIX. This price convergence in the VIX and VIX front month futures is always interesting to watch, but particularly so in high volatility environments.

The mechanics of the VIX settlement process are non-trivial, but suffice it to say that they settle with a Special Opening Quotation (SOQ) at Wednesday’s open, based upon opening trades (as well as the midpoint between the bid and ask) in SPX options. As a result, the last opportunity to trade VIX August futures and options is the session before the SOQ, at Tuesday’s close.

With two full trading days plus 1 ½ hours of today’s session left, there is a substantial discrepancy between the VIX and the VIX futures. As I type this, the VIX is at 36.40 and the August VIX futures are at 34.50. Somehow that gap needs to be closed in the next two days. Right now the market’s best guess is that the VIX will fall 1.90 points by Wednesday’s SOQ, but of course the final settlement could be between the two current values and quite possible above 36.40 or below 34.50. If you are trading any of these instruments, you should be aware of the price gap and the path of the convergence. You might also use this opportunity to brush up on the little-known near-term month VIX index (VIN) by checking out VIN, VIF and an Obsolete VIX.

Related posts:

• VIN, VIF and an Obsolete VIX
• Ten Things Everyone Should Know About the VIX
• Rule of 16 and VIX of 40

Mark Longo and Options Insider Radio recently conducted an extensive interview with Jay Caauwe, Director of Business Development for the CBOE Futures Exchange (CFE).
As regular readers know, I believe that an understanding of VIX futures is the cornerstone for being able to analyze and trade successfully the entire VIX product space, including VIX options and VIX exchange-traded products.
For those who are looking to get up to speed as soon as possible on VIX futures or perhaps just enhance their existing knowledge base, I recommend listening to Options Insider Radio 83: The Future of VIX Futures.
Related posts:

• Appearance on The Options Block