I have been trading the Volatility Index (VIX) since it was first created in 1993.
Let me tell you, the Volatility Index we have today is not your father's Volatility Index.
The (VIX) was originally a weighted measure of the implied volatility of just eight S&P 100 at-the-money put and call options.
Ten years later, in 2004, it expanded to use options based on a broader index, the S&P 500, which allows for a more accurate view of investors' expectations on future market volatility. That formula continues until today.
There were two generational lows in the (VIX) that have taken place since inception.
The first was in 1998 during the heyday of the mammoth hedge fund Long-Term Capital Management. The firm sold short volatility down to the $8 level and used the proceeds to buy every bullish instrument in the universe, from Japanese equities to Danish mortgage bonds and Russian government debt.
Then the Russian debt default took place and the (VIX) rocketed to $40. LTCM suffered losses in excess of 125% of its capital, and went under in two weeks. It took two years to unwind all the positions, while the (VIX) remained $40 for a year.
To learn more detail about this unfortunate chapter in history, please read When Genius Failed by Roger Lowenstein. The instigator of this whole strategy, John Meriwether, once tried to hire me and is now safely ensconced in a massive estate at Pebble Beach, CA.
The second low came in January of 2018, when the (VIX) traded down to the $9 handle. This time around, short exposure was industrywide. By the time the (VIX) peaked on the morning of February 6, some $8 billion in capital was wiped out.
So here we are back with a (VIX) of $20.48. But I can tell you that there is no way we have a (VIX) $20.48 market.
This is because (VIX) is calculated based on a daily closing basis. It in no way measures intraday volatility, which lately has become extreme.
During 11 out of the last 12 trading days, the S&P 500 intraday range exceeded 2%. This is unprecedented in stock markets anywhere any time.
It has driven traders to despair, driven them to tear their hair out, and prompted consideration of early retirements. The price movements imply we are REALLY trading at a (VIX) of $50 minimum, and possibly as high as $100.
Of course, everyone blames high frequency traders, which go home flat every night, and algorithms. But there is a lot more to it than that.
Heightened volatility is normal in the ninth year of a bear market. Natural buyers diminish, and volume shrinks.
At this point the only new money coming into equities is through corporate share buybacks. That makes us hostage to a new cycle, that of company earnings reports.
Firms are now allowed to buy their own stock in the run up to quarterly earnings reports to avoid becoming afoul of insider trading laws. So, the buyers evaporate a few weeks before each report until a few weeks after.
So far in 2018 this has created a cycle of stock market corrections that exactly correlate with quiet periods. This is when the Volatility Index spikes.
And because the entire short volatility industry no longer exists, the (VIX) soars higher than it would otherwise because there are suddenly no sellers.
So, what happens next when companies start reporting Q1, 2018 earnings? They announce large increases in share buybacks, thanks to last year's tax bill. And a few weeks later stocks take off like a scalded chimp, and the (VIX) collapses once again.
That's why the Mad Hedge Fund Trader Alert Service is short the (VIX) through the IPath S&P 500 VIX Short Term Futures ETN (VXX) April, 2018 $60-$65 in-the-money vertical bear put spread.
Just thought you'd like to know.
