SPX Through 11-13-09

A breakout above 1100 would be bullish, and could probably propel prices to the 1150 level without much trouble. However, a failure at 1100 means that support areas would be important. There is support at 1160-1170, near the 20-day moving average, and then below that at 1030, the late October lows, followed by 1020, the early October lows.

There are now breadth sell signals as of today’s failure at 1100. Also, there is a matter of negative divergence: breadth rose to much higher levels when $SPX first visited 1100 a month ago.

VIX Through 11-13-09

In summary, the intermediate-term trend of the $SPX chart continues to be bullish. However, there are several potential short- term negatives which mean that another correction could be about to emerge. A close above $SPX 1100, however, would essentially end bearish thoughts.

This is more of “what the…” chart more than anything tradeable, but it’s interesting that as of the latest release covering positions through the June 9th close, the CFTC shows that large speculators are net long VIX futures to a degree not matched in the past few years.

Normally, large speculators are more of a contrary indicator than anything when their positions reach an extreme, but that hasn’t worked in the VIX.  This is a relatively new futures contract, and it can act pretty screwy when compared to the cash VIX index, but the last couple of times we saw large specs build big positions (relatively speaking) in the futures, we saw implied volatility jump over the next couple of months.

There was a temporary spike in their positions in early March of this year which was quickly reversed before volatility began to fall, but that’s still kinda sorta a false signal.  Anyway, like I said, I wouldn’t trade on this by any means, but it does make me raise one eyebrow just a bit.

OK, apparently caused lots of dissenting opinion in regards to slapping on a spread that involved going long VXX and short SPY near term options.

So let me clarify a few points.

This is just a convoluted way around a relatively simple trade, an SPX or SPY calender. So what if we forget VXX and VIX futures exist. The basic thought here is

when volatility caves, I generally would prefer owning calenders. That involves buying longer dated options at likely a higher volatility than I am selling the shorter term options. It gets me short gamma and earns money in the form of time decay.

You have to look at this as two separate transactions though. The short side of the options will earn me money if the realized volatility between now and expiration is less than the volatility I sold them for. Yes, part of that trade likely involves chasing stock into strength and shorting it into weakness. The idea is to lose less doing that than you earn in options attrition.

The long side of the calender is more of a bet on implied volatility at least holding steady. You will not lose all that much time decay, but you are at risk of a move lower in volatility. But if you think options volatility is a buy longer term, you are OK with that.

So combine the two and you are effectively betting on longer term implied volatility to outperform shorter term realized volatility. If you think that’s a good bet, a calendar makes sense.

Using VXX or a VIX future in lieu of a longer dated SPX or SPY option is not identical, but you will win or lose with it in a similar pattern as above.

But it’s important to remember however you chose to go long a longer dated option, it’s not a big deal if you “buy” higher volatility than you sell. It’s two different time frames and two very different bets, there’s no reason they will or should carry the same volatility. A few weeks ago they all did carry about the same volatility. That’s more unusual than not.

So what’s the risk in buying a calendar, or buying VXX and shorting SPY options?

It’s not that some small volatility difference between the two cycles will revert to 0. There are 2 big risks however. One is that realized volatility, which you are effectively shorting, will explode and longer term volatility will not lift as much. You would have got hit massively with that last Fall. Which is why I don’t like this position in a rising volatility environment.

The other risk is that all volatility caves in. Your short volatility will only earn you so much, I mean your options can only go to zero and you will get lousy prices trying to roll them. Meanwhile your VXX or VIX future or longer dated SPY straddle has gotten mauled.

Post getting long here. To be Continued.

Nothing much doing in the VIX options products lately as per Jamie. Just to prove I don’t make up the “Friday Effect” that accounts for modestly depressed VIX readings, Jamie says it too in this video. Which I guess doesn’t actually prove us right, just that we agree that it happens.

The big plays have been way upside call speculation in July VIX. Buyers of the July 45-55 call spread, and the July 50 calls straight up. Keep in mind, these are cheap dollar amount plays and perhaps just a form of insuring a portfolio after a nice run.

On the futures front, interesting stuff here from Jason Goepfert.

…..as of the latest release covering positions through the June 9th close, the CFTC shows that large speculators are net long VIX futures to a degree not matched in the past few years.

Normally, large speculators are more of a contrary indicator than anything when their positions reach an extreme, but that hasn’t worked in the VIX. This is a relatively new futures contract, and it can act pretty screwy when compared to the cash VIX index, but the last couple of times we saw large specs build big positions (relatively speaking) in the futures, we saw implied volatility jump over the next couple of months.

From The Daily Options Report by Adam Warner on the seasonal cycle of volatility.  It bottoms end of June beginning of July, then picks up in the summer for a peak in the fall.

For all the talk about “bottoming” the VIX, I would like to throw one little splash of cold water on it.

As per numbers I ran for my book, Options Volatility Trading: Strategies for Profiting from Market Swings(Amazon link) July cycle shows the lowest mean and median VIX readings. Early in the July cycle, really from June expiration into July 4th or so, is particularly bad, and in fact often is the low water mark of the year.

So with “cheap” options volatility already overpriced relative to realized volatility, and the last week of a cycle not a good time to buy options of the following cycle under any circumstance, I’d really refrain from “bottom fishing” July paper here. It will likely get cheaper in volatility terms.

Now none of this says anything about actual stock volatility this coming week. It’s expiration, anything can happen. I tend to think that if it’s non-volatile heading into expiration week, it stays that way. But you always have the chance of an event getting some names on the move. What it does say though is not to let a potential active day or two seduce you into buying July options. Treat it as a blip in volatility, not the start of a new trend up.

And none of this says anything about VIX futures, or VXX. Remember the VIX future just looks at a snapshot VIX reading for the day it expires. The pattern is ugly volatility early in the July cycle, but the VIX may very well rebound by the end of the cycle. Expect VIX July futures to keep a healthy premium to “cash”.

Traders like looking at the VIX to get an impression of the mood of the market.  If VIX spikes up, that is taken as a buy signal.  Since a spike in VIX speaks of market fear which is often overdone.

The VIX is calculated as a weighted average of the implied volatility of the nearest two SPX options series.  That is its link to the movement of the index, since the implied volatility is the measure of the expected movement of the index in one year.

Since the crowd is generally better informed than any single individual, it is worth understanding what the market as a whole says that volatility is going to do over time.  Is the going to be a crash in the fall?  Is the summer going to be quiet in the market?

In March 2004 the CBOE Futures Exchange (CFE) created futures contracts on the VIX.  Then two years later the CBOE created options on the spot VIX in the near month, and the later month options trade off the fuutres contracts.

The same information is in the SPY options series, except that it isn’t aggregated over the whole option series the way VIX does.  So if we want to look at the term structure, that is, how the volatility varies through time, we can look at the at the money SPY options too.  It should agree with the VIX futures data.

So if we look at the SPY 92 options what do they predict?  (SPY is at 91.75 right now.)

So we see that the expected volatility is very flat all the way out to March of next year. No crash in the fall is expected. A summer much like this spring.

We’ll see.