(VXX) Archives - Page 16 of 16 - Mad Hedge Fund Trader

What?s Going on With the VIX?

After crawling off the mat at the 12% level, and rising all the way back up to 21%, traders are wondering if the Volatility Index (VIX) is finally coming back to life. Or is this just another dead cat bounce?

It wasn?t supposed to work that way. Falling markets should send investors scrambling to buy downside protection in the form of put options, which would automatically send the (VIX) soaring. Except when they don?t.

I spoke to over a dozen market participants yesterday attempting to root out the cause of this seeming anomaly. All I got was shrugs or idle speculation. A (VXX) at this level, the ETF for the (VIX) assumes that the complacency now endemic in the market will continue for several more months. It is betting that the S&P 500 will continue moving sideways or up with no pullbacks greater that 5%. Oh, really?

It is also discounting a rise in the (SPX) to 1,750, based on a multiple expansion from 16 to 17, while corporate earnings are falling. This will see confirmation when Q3, 2013 earnings start to hit in October. Oh, really, again?

I finally got through to some friends in the Chicago pits who explained what was going on. A sizeable portion of the trading community believes that we will see a rise in volatility someday, but not in the near future. So they have been buying October call options in the (VIX). To pay for these and hedge out their risk, they have been selling short calls in the front months of December and March at much higher implied volatilities.

Since the (VXX) focuses on only the front two months of the options calendar, it has taken an inordinate brunt of the selling. This is why the (VXX) has continued a rapid decent even on days when the (VIX) was stable and the Dow was down. Needless to say, it has been a huge moneymaker for the early participants.

How does this end? At some point we do get a serious sell off in the stock market, and the (VIX) rockets back up to 30%, or higher. That means that anyone who initiates this position now will get slaughtered. But the long-term players will simply write those losses off against the substantial short dated premium they have taken in until then.

As long as this dynamic is in place, there really is no limit to how far the (VXX) can fall. As traders roll from one expiring month to the next, they will continue to hammer volatility.

What?s Going on With the VIX?

Diary, Newsletter

After crawling off the mat at the 12% level, and rising all the way back up to 19%, traders are wondering if the Volatility Index (VIX) is finally coming back to life. Or is this just another dead cat bounce?

It wasn?t supposed to work that way. Falling markets should send investors scrambling to buy downside protection in the form of put options, which would automatically send the (VIX). Except when they don?t.

I spoke to over 30 market participants yesterday attempting to root out the cause of this seeming anomaly. All I got was shrugs or idle speculation. A (VXX) at this level, the ETF for the (VIX) assumes that the complacency now endemic in the market will continue for several more months. It is betting that the S&P 500 will continue moving sideways or up with no pullbacks greater that 2%. Oh, really?

It is also discounting a rise in the (SPX) to 1,750, based on a multiple expansion from 16 to 17, while corporate earnings are falling. This will see confirmation when Q3, 2013 earnings start to hit in October. Oh, really, again? It will do this in the face of economies that are dramatically slowing in both Europe and China. Oh, really, a third time?

I finally got through to some friends in the Chicago pits who explained what was going on. A sizeable portion of the trading community believes that we will see a rise in volatility someday, but not in the near future. So they have been buying September call options in the (VIX). To pay for these and hedge out their risk, they have been selling short calls in the front months of December and March at much higher implied volatilities.

Since the (VXX) focuses on only the front two months of the options calendar, it has taken an inordinate brunt of the selling. This is why the (VXX) has continued a rapid decent even on days when the (VIX) was stable and the Dow was down. Needless to say, it has been a huge money maker for the early participants.

How does this end? At some point we do get a serious sell off in the stock market, and the (VIX) rockets back up to 20%, or higher. That means that anyone who initiates this position now will get slaughtered. But the long term players will simply write those losses off against the substantial short dated premium they have taken in in the meantime.

As long as this dynamic is in place, there really is no limit to how far the (VXX) can fall. As traders roll from one expiring month to the next, they will continue to hammer volatility.

Markets Can Remain Irrational Longer Than You Can Remain Solvent

The Final Word on the Volatility Index

Newsletter

The inside story on the collapse of volatility is now out, and as a result, managers are reviewing the harsh lessons learned and tweaking their strategies. It highlights the dangers of buying securities without reading the prospectus and understanding what is under the hood.

As investors piled into stocks in February, they also bought downside protection in the form of the Velocity Shares Daily 2X VIX Short Term ETN (TVIX). For reasons that are yet to be explained, the issuer, Credit Suisse, arbitrarily decided to quit issuing new shares, effectively turning this vehicle into a closed end fund. Money poured in anyway, driving the price up to a 100% premium over the intrinsic value of the fund.

Then, out of the blue, Credit Suisse reversed its decision and decided to issue new shares after all last week. This could mean only one thing to the professional volatility trading community, which jumped on the (TVIX) with both feet. They took the ETF down a stunning 65% in a week, all the way down to a 20% discount to intrinsic value. During the same time, the (VXX) fell by 25%, while the (VIX) was up 10%. Now that?s a tracking error with a turbocharger!

It now appears that there was some advanced knowledge about the reissuance of shares, and the SEC is almost certain to make inquiries. Those who had hoped for downside protection in the stock market got a slap in the face instead. To say the least, confidence in the financial system has not been advanced.

To make matters worse, a major hedge fund based in Chicago has a gigantic position in the (TVIX) with a ?put tree?. This involved buying one $21 put and selling short one $18 put and three $17 puts. Below $17 they were 300% long the (TVIX). When the ETF broke that level, the sushi hit the fan, triggering panic selling of all (VIX) products at any price, including the unrelated (VXX). I can?t tell you who it is without risking litigation. But with the quarter end upon us, their investors will find out soon enough. Watch the newspapers to find out whom.

The debacle has sent analysts scurrying to find other ETF?s that may be trading at premiums to their underlying. Here are the top three:

Platinum (PGM) 27%
Municipal bonds (GMMG) 14%
China small cap (PEK) 6%

The premium in the (UNG) frequently goes as high as 50% and results from the contango in the futures market, where far month contracts are trading at big premiums to the front month. That makes it a great shorting vehicle in falling markets, because the ETF always falls faster than the underlying. I have drunk at this well many times.

What happens from here? My guess is now that managers see that their downside protection is a sham, they won?t want to play. That could translate into stock selling, now that holders understand that these positions involved more risk than they realized.

In the meantime, if you plan on dabbling in the $1.4 trillion 1,400 issue ETF market, it may prove wise to check out the intrinsic value of any ETF before you buy it. You can do this easily by going to Yahoo Finance and adding .iv to any ticker symbol. So while the (TVIX) intrinsic value this second is at $7.51, the current market is at $7.96, a 6% premium. If you value your wealth, you might well get familiar with this exercise.

Trading Volatility Isn?t Always So Fun

Volatility Melt Down Continues

Newsletter

The market was buzzing today about the continued collapse of volatility and the significance thereof today. Today the chief whipping boy was the double leveraged Velocity Shares 2X Vix ETF (TVIX), which cratered 33% on the day, and down 90% from its October high.

This was on a day when the ETF should have gone through the roof, with the Dow down 100 points and a rapidly deteriorating Chinese Purchasing Managers Index threatening of worse to come. Even the (VIX) and the (VXX) only brought in modest gains at best. Against this backdrop they should have been up much more.

Conspiracy theories abounded. Some speculated about margin calls on a major hedge fund triggering a forced liquidation. Other?s thought that complacency was peaking, creating spike bottoms in volatility products that could signify a final move. Certainly a buying opportunity is setting up here, but how do you determine where when the ETF is doing the exact opposite of what it is supposed to do.

Whatever the reason, investors? trust in these instrument has been permanently dented. A 33% one day drop certainly was not in the prospectus.

What?s Going on With the VXX?

Newsletter

Much of Wall Street was scratching their heads yesterday as the iPath S&P 500 Vix Short Term Futures ETN (VXX) plunged to new lifetime lows despite a 69 point decline in the Dow index. It wasn?t supposed to work that way. Falling markets should send investors scrambling to buy downside protection in the form of put options which would automatically send the volatility index skyward. Except when they don?t.

I spoke to over 30 market participants yesterday attempting to root out the cause of this seeming anomaly. All I got was shrugs or idle speculation. A (VXX) at this level assumes that the complacency now endemic in the market will continue for several more months. It is betting that the S&P 500 will continue moving sideways or up with no pull backs greater that 2%. Oh, really?

It is also discounting a rise in the (SPX) to 1,500, based on a multiple expansion from 14 to 15, while corporate earnings are falling. This will see confirmation when Q1, 2012 earnings start to hit in April. Oh, really again? It will do this in the face of economies that are dramatically slowing in both Europe and china while oil prices are spiking. Oh, really, a third time?

I finally got through to some friends in the Chicago pits who explained what was going on. A sizeable portion of the trading community believes that we will see a rise in volatility someday, but not in the near future. So they have been buying June and September call option in the volatility index (VIX). To pay for these they have been selling short calls in the front month April and May calls.

Since the (VXX) focuses on only the front two months of the options calendar, it has taken an inordinate brunt of the selling. This is why the (VXX) has continued a rapid decent even on days when the (VIX) was stable and the Dow was down. The first hint we got of this was on Monday, March 12 when traders started to roll in earnest from the March to the April (VIX) contract.

When they started executing this trade in December, both the short term and long term volatility were trading around 28. Holding a June or September call while selling calls for each expiring month against it has kept long dated volatility high at 28, but driven short term volatility down to an eye popping 14. Needless to say, it has been a huge money maker for the early participants.

How does this end? At some point we do get a serious sell off in the stock market, and the (VIX) rockets back up to 28 or higher. That means that anyone who initiates this position now will get slaughtered. But the long term players will simply write those losses off against the substantial short dated premium they have taken in in the meantime.

As long as this dynamic is in place, there really is no limit to how far the (VXX) can fall. As traders roll from one expiring month to the next, they will continue to hammer volatility. So when the (VXX) hit my stop loss at $20, the previous lifetime low for this contract, I let it stand and followed up with a trade alert reminder investors to bail.

Any loss that you don?t learn from is a wasted lesson that is bound to be repeated. The key in this situation is to make sure the hits don?t become life threatening by limiting them to small single digits. The combined loss of my two errant (VXX) trades came to -3.46% for my notional $100,000 portfolio. That is not the end of the world. It simply cancels out the profits I made earlier on my short positions in the Japanese yen and natural gas, as well as my long call spreads in Apple and Microsoft. Coming out here also lets me shrink and neutralize my book, a good think in these uncertain times.

I?m sure we?ll see the (VXX) above $30 sometime this year. I just don?t want to bleed to death before it happens.

Markets Can Remain Irrational Longer Than you Can Remain Solvent

Buy Christmas Ornaments in January With the (VXX)

Diary

I am a notorious seeker of great bargains. I buy sun hats in the winter, umbrellas in the summer, and Christmas ornaments in January when Costco sells them for ten cents on the dollar. I even go into the barrio to buy Japanese sake where no one knows what it is, and it is sometimes ordered by accident.

I?ll tell you what I like about the (VXX). It is a bet that someday, somewhere, something bad happens. Since it is not an option, it doesn?t suffer from time decay, and the cost of carry is low. The contango costs are modest. It can be used to hedge the downside risk for a whole range of ?RISK ON? assets, including those garden variety shares in your plain vanilla IRA?s and 401k?s.

If you have a PhD in math from MIT, then you?ll already know that The IPath S&P 500 Vix Short Term Futures ETN (VXX) offers exposure to a daily rolling long position in the first and second month (VIX) futures contracts and reflects the implied volatility (Black Scholes method) of the S&P 500 index at various points along the volatility forward curve. The index futures roll continuously throughout each month from the first month VIX futures contract into the second month VIX futures contract.

If you don?t have such a degree, then this is all you need to know. If the stock market goes up, then the (VXX) goes down. If the stock market goes down, then the (VXX) goes up. The beauty of the (VXX) is that it doesn?t care where the down move starts from, whether it is with the (SPX) here at 1,340, at 1,400, or 1,450. Until then, it will just grind around these levels or go slightly lower.

So if the (SPX) continues to go up, you might lose 10% on the position. If we get the long predicted 5% correction, then it should rise 30% to $32, or back to where it was in January. If we get the summer swoon that I expect, then it will nearly triple to $58, its October high. It is the classic ?heads you win $1, tails, I win $3 type of bet that hedge funds are always looking for.

A direct investment in (VIX) is not possible. The S&P 500 (VIX) Short-Term Futures Index holds (VIX) futures contracts, which could involve roll costs and exhibit different risk and return characteristics. And if your timing is off just a bit, then the time decay will eat you alive if the arbs don?t get to you first.

If you want to learn more about the (VXX), the go to iPath?s page for it at http://www.ipathetn.com/product/VXX/.

Learn to Love Volatility

The Looking Glass Market

Diary

If you feel like this market has sucked you down a rabbit hole, you have plenty of company.

I have never seen such a profusion of contrary cross market indicators. Traders are running up shares prices while companies are cutting earnings forecasts. Economists are raising GDP forecasts as rising energy prices are taking them the opposite direction. Natural gas is crashing as oil spikes up.

The bond market has gone catatonic, with billions pouring into bond mutual funds to keep them on life support. Dr. Copper, that great leading indicator of global economic activity, has gone to sleep, with investors pouring money into the entire spectrum of risk assets. An increasing share of the buying in equity markets is focusing on a single stock, Apple (AAPL), the world?s largest company.

They say the market climbs a wall of worry. This one is climbing the Great Wall of China. You have to assume that the people buying stocks here are doing so only for the very long term, Warren Buffet style, and are willing to look past any declines we may see this summer. They don?t care if the market drops 5%, 20% (my pick), or 50%.

In my new year Annual Asset Class Review I thought that markets might peak in January. I lied. Thanks to a global quantitative easing program, it is increasingly looking like 2012 will be another ?sell in May and go away? year, the fourth in a row. You might as well book that Mediterranean super yacht, the beach house in the Hamptons, or the bucolic chalet in Switzerland now to beat the rush.

Another ?looking glass? element this year is the extent that last year?s dogs became this year?s divas. Just look no further than Bank of America (BAC), which did a 67% swan dive in 2011, but has soared a blistering 51% this year. This is a stock with a PE multiple of 812 and more investigations underway than Al Capone every saw.

It goes without saying then that those who did terrible in 2011 are looking like stars today. Look no further than hedge fund titan John Paulson, whose flagship fund was down 50% at the low last year, thanks to a big bet on financials. This year it appears his super star status is restored. Other funds that made big bets last year on European stocks and sovereign bonds have been similarly revived. If MF Global had only lasted two more months, John Corzine would be looking like a genius today, instead of a goat.

When I realized that this could be a ?dogs of the Dow? year with a turbocharger, I quickly reviewed by own money losing trades in 2011. That prompted be to rush out but puts on the Japanese yen, which doubled in short order, and haven?t looked back since. Now you really have to ask the question, will my other 2011 losers perform similar turnarounds? What?s at the top of the list? The (TBT), my bet that long term Treasury bonds would go down, which inflicted my biggest hickey last year.

By the way, I?m kind of liking the volatility ETF (VXX) here. If the markets keep going up forever you might lose 10%. If they don?t, you will make a quick 30%, and 100% if volatilities return to the highs seen in October. The cost of carry is modest, there is no time decay as with options, and there is no contango. In fact, near month volatility is trading at half the levels of long term volatility. That is the kind of risk/reward ratio that I am constantly looking for.

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