Two Bulls--Two Bears

20 April 2009

I generated an 11 year graph of Spy this morning: 

I'm not a big chartist--I don't believe that patterns from the past can reliably predict the future (see Fooled by Randomness by Taleb), but a couple things are striking:

• The recovery time from the 2000 bear market was significant--it was roughly a year after things hit bottom before the next bull market really got going.
• The speed at which the current bear market dropped was breathtaking.  No wonder people were freaked out.  
• It is really optomistic to think that the next bull market is starting now.   Look for some sideways action for a few months at least.  A "V" shaped recovery after a drop like this certainly exceeds my generally optimistic outlook. 

Pseudo Buy-write Long on VXX, Short on VIX calls

On 9-April I put this pseudo buy-write in play:  VXX at 102.68,  Bear Spread--short VIX 30 Apr Calls, long 42.5 Apr Calls for a 8.45 credit.    Bid-Ask spreads were substantial on both of these orders.  I think about 0.35 on the VXX and more on the calls.  With the credit spread order I was able to get fairly close to the asked side of things on the 30 Apr call, but I ended up chasing the market a bit on my limit orders on VXX, so I ended up offering the ask price at the end. 

There were a  couple of surprising things with this trade.   I tried to create the spread with the long side with May expiration--and failed.  Since the Apr options expire on Wednesday and I am only buying the calls to keep the broker happy there wasn't much extra cost associated with going out to the May call.   A few minutes after I put in the order I got a call from my broker telling me that my order was cancelled. The spread has to be in the same calendar month!   The broker didn't sound all that confident that he knew why, but he mentioned the European expiration, and the fact that volatility doesn't have calendar premium that other options do.  I can see the dynamic to a degree--if volatility jumped up dramatically, the longer out call would not respond as directly, and would probably even drop below the strike price.  

For me the additional exposure was not a concern because I am hedging with the VXX, but I can see the normal tracking of equity options and most index options might not happen with the VIX options.     Not to worry, it was easier, and cheaper to establish an April position on the long side. 

The other surprise was the amount of premium available on the 30 April call.   With 4 days left this deep in the money call (7.70 in the money) had 1.15 of premium accessible--an implied volatility (IV) of around 275%!  The ITM call is around 90% I think.   This amount of IV pretty confidently states there is no hedge around for the VIX--hopefully the market is wrong on this one.   I went for a call this deep in the money, giving up more premium, because I wanted the down side protection that this call provides--the market could easily climb some more this next week.   The good news is that even though the bid-ask spread is very wide on these ITM options the market is willing to deal--at least half way in-between.

I have been tracking the VXX vs. the VIX index for a while.  I'm pretty sure the goal of the VXX is to match the short term deviation of the VIX, not the percentage variations.  The graph below shows the behavior: 

The VXX , VIX, and SPY values are shown relative to the mean of the three instruments for January / February.  I waited until the absolute value of the VXX was low, the relative VIX was pretty close to the VXX, and tried to take advantage of the known tendency of the VIX index to drop on Fridays and rise on Mondays to reflect the time value decay over the weekend. 

The VIX options expire Wednesday morning, so I need to reestablish the spread for May on Tuesday to stay hedged.  I don't know how much the premium will decay on Tuesday--I've never watched them that close to expiration before.    The exercise value for the options is established at Wednesday market open, so I suppose there isn't too much risk in waiting until Wednesday morning opening to re-establish the spread. 

Overall debit for the position was 94.23.  At the end of Thursday the position was at 93.81. 

Good Wednesday before Good Friday or Bad?

11:00 P.M. 7-Apr

There was an interesting combination of factors today on the market today, at least with SPY and $VIX/ VXX.  Volume on SPY was quite low today as SPY dropped--is this because of the holiday weekend coming up, or are people staying on the sidelines expecting more givebacks from the recent rally?   

In spite of a 2% drop in SPY the $VIX index did not act particularly fearful.  Do the options traders know something we don't?  

The Asian markets are off pretty strongly at 11:00 PM MT.  My guess is that the US markets will open  down substantially in the morning.   

Update  7:30 AM 8-April

Spy opened up approx $0.50 this morning.  It appears that the VXX/VIX were better predictors than the Asian stock market or the low volume yesterday.   Made a 80.22 Debit order on Buy-Write of SPY and April 80 calls.  Tried to make the order with Fidelities advanced options debit order function, but it was not working well.  I saw the debit price go well below my asking price without triggering--that's what you get when you have actual humans involved.    

Premium was about $1.80 with 10 days left  which gives 2.2% on the order. 

VXX -- The New Clown in Town?

Apparently the new VXX ETF is designed to have the same annualized percentage standard deviation (not sure what this means) as the VIX (see prospectus/ info sheets).   Since the SD is given in points, not percentages this could be really confusing.   It is actually possible that the VXX quants are shooting for a dollar, not percentage correlation with the VIX.  If this is the case then 100 shares of VXX would be the equivalent underlying for a VIX option.  

 Probably will be inherently less volatile than the VIX on big days.  May be more of the fear and greed gauge -- it might have the tendency to go down more than the VIX on big positive S&P moves.  

Interesting scenarios are possible.   VIX options are basically worthless for short-term volatility trading because their prices poorly track the short term moves in the VIX (their European exercise attribute makes this possible).   The VXX looks like it will move as quickly as the VIX, but not as strongly--at least on a percentage basis.   So you can simply go long on volatility, or do a pseudo buy-write with VIX calls.  Since the VIX ITM options have outrageous volatilities and don't track upside moves well this is doubly interesting.    

 Since VXX doesn't count as an underlying for VIX calls I would have to do short spreads to make the options police happy (no naked calls for you!) -- which limits me to my taxable account and makes debit / credit orders not possible. 

 On the negative side, VXX will have a naturally declining characteristic "term structure decay" (whatever that is), has a high expense structure (.89%), and are not guaranteed at all to faithfully follow the VIX.   No one seems to think this is a good buy and hold purchase. 

 On the other hand, if they want to stay in business they better be pretty good at mimicking the VIX.