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Volatility Floored

The following post was initially issued to TLS members on May 11, 2018.

The VIX may struggle to move much lower than current levels — and may signal limitations to further stock market gains.

Some folks argue that technical analysis cannot be applied — and therefore should not be attempted — on volatility markets. We actually used to be in that camp but, given the evidence we’ve observed over time, we have changed our tune. We think support and resistance levels, particularly via trendlines, have been readily identifiable on many occasion. And one pretty significant signal in that regard may be in the works at the moment.

Since its high in 2015 (coinciding with the S&P 500 low), we’ve seen a discernible downtrend in the VIX (S&P 500 Volatility Index). Not only that, but the intermittent VIX peaks over that time serve to form a nearly pristine Down trendline on the chart. Now, it seems that the likelihood of such a clean trendline forming at random is nearly inconceivable. However, we’ll let pundits and philosophers opine on the topic of TA and volatility charts. We are operating under the assumption that recent action is notrandom — and that such analysis can assist us, at times, in our stock market decision-making. One of those times, again, may be now.

As the chart shows, the VIX did finally break above its post-2015 Down trendline in late January/early February of this year. After its subsequent spike into early February, the VIX settled back down. Where did it find support? Right on the top of the broken post-2015 Down trendline on March 9. While it was bouncing firmly off of that support, stocks were, at the same time, stalling out, eventually turning back down to test its February correction lows.

Following the VIX’s bump up in volatility into April, it has settled back down again. And presently, as stocks have bounced again, we find the VIX once again nearing a test of that broken post-2015 Down trendline.

As it did in March, the trendline may provide nearby support for the VIX. If successful, that may also serve as a signal that further upside in stocks may be tough to come by in the near-term.

Obviously, only prices will tell the story, but one reason we look at other indicators, e.g., breadth, sentiment, etc., is because price is not predictive. Other metrics can help us anticipate what prices are likely to do going forward. And at the present time, potential VIX support may again be signaling a possible roadblock, or pause, in the current stock market bounce. At a minimum, that would have us holding off on chasing stock prices higher. They certainly may end up moving higher, but the risk/reward prospects of buying stocks right here would not appear to be too favorable.

If you’re interested in the “all-access” version of our charts and research, please check out our new site, The Lyons Share. You can follow our investment process and posture every day — including insights into what we’re looking to buy and sell and when. Plus, our SPRING SALE (25% OFF!!) is going on now so it’s a great time to sign up! Thanks for reading!

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Disclaimer: JLFMI’s actual investment decisions are based on our proprietary models. The conclusions based on the study in this letter may or may not be consistent with JLFMI’s actual investment posture at any given time. Additionally, the commentary provided here is for informational purposes only and should not be taken as a recommendation to invest in any specific securities or according to any specific methodologies. Proper due diligence should be performed before investing in any investment vehicle. There is a risk of loss involved in all investments.

#$^VIX #$^VXX #$UVXY #$XIV #$SPY #$^GSPC

Is Volatility Back On The Rise?

Short-term volatility expectations took a dramatic spike higher Monday.

“Be greedy when others are fearful”, Warren Buffet famously said. In our experience, it is wise counsel -- if you have the intestinal fortitude to implement such an approach. The key, of course, is how to reliably measure fear. That is, how do you know when fear is elevated enough to be greedy? It is not necessarily a straightforward task as there are countless ways of measuring investor fear, and over various durations. In this post, we highlight one volatility-based indicator that is signaling elevated levels of fear in the short-term. But is it enough evidence for traders to get greedy -- or is it a sign that volatility is on the rise?

The indicator is the short-term S&P 500 Volatility Index, or VXST. It is just like the VIX, but it measures volatility expectations over the next 9 days as opposed to the next month. Monday (3/19/201), amid the Facebook-led selloff, we saw the VXST put in one of its sharpest spikes of all-time, at least on an intraday basis. At its high, the VXST hit a high of 29.09, a gain of 95% from the prior day’s close. It ended the day off of its highs, closing up by 47%. But that intraday spike nearly marked only the 5th occasion since the VXST inception in 2011 in which it doubled its prior day’s closing price at its intraday high.

So did this VXST spike constitute a buy signal, at least in the near-term? With just 4 historical precedents, it’s difficult to make a determination off of this one data point. Expanding the parameters to look at other large VXST spikes (instead of just “doubles”), we see that sometimes they occurred at the beginning of corrections and opened a path to a higher volatility environment. At other times, however, they closely marked the end of selloffs.

Did this recent spike signal enough fear to begin being greedy again? Or are we headed into an elevated volatility environment for some time? In a Premium Post at The Lyons Share, we break down the VXST spike data further and come to a determination about whether we should get greedy now or buckle up for more volatility.

If you are interested in the Premium version of our charts and research, check out our “all-access” service, The Lyons Share. You can follow our investment process and posture every day — including insights into what we’re looking to buy and sell and when. Thanks for reading!

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#$^VIX #$^VXST #$XIV #$UVXY #$VXX

After Storm, Volatility Speculators Pull A 180

Non-Commercial Speculators in VIX futures have now flipped from their largest net-short position ever, to their largest net-long position.

One of the key components, and perhaps drivers, of the recent stock market plunge was the activity within the volatility market. As everyone was aware, the monetary size (and one-sidedness) of the “short volatility” trade in recent months grew to mammoth proportions. As everyone was also aware, that position became untenable. Everyone knew that sooner or later, the short vol trade would blow up, just not how or when. Well, the spectacularity and unpredictability of last week’s blow-up did not disappoint (unless you were knee deep in short vol).

As for the “when”, that too had been previously unknown, or unknowable. The trade certainly succeeded for far longer than most anticipated. For example, in a post in late September, we mentioned that “Non-Commercial speculators in VIX futures had built up their largest net-short position (~175K contracts) of all-time, by a long shot. Given the wildly imbalanced bet against volatility, these traders must have recognized the tremendous risk involved. Yet, like the picture we included in that post of the man mowing his lawn in the shadows of a tornado, traders continued to add to their short vol positions, and avoid any stormy weather…until the past few weeks.

We knew the short vol blow-up would be devastating, but we didn’t know exactly how it would unfold, or how extensive the unwind would be. Now that the dust has settled a little bit, we see that, in some cases, it was an absolute and total unwind. Not only that, but in the case of the VIX futures speculators, they have actually pulled a complete 180 and now hold the largest net-long position (~86K contracts) in the history of the contract (as of a week ago).

With the notoriously “dumb money” speculators (at least at extremes) at their largest net-long position ever, we are left to wonder if they have now gone too far in the other direction. Are they too prepared for continued elevated volatility and is vol liable to settle back down again? And by extension, was the stock selloff overdone, opening the way for a further snap-back rally in equities?

Those questions certainly may be answered in the affirmative going forward here in the near-term. Perhaps the most important takeaway, however, is the broad commentary on the risk inherent in the volatility market. To go from the largest net-short position of all-time to the largest net-long in such a short time gives you an idea of the suddenness of the potential moves here as well as the fragility of this market.

You certainly won’t catch us mowing the lawn in front of this tornado.

If you’re interested in the “all-access” version of our charts and research, please check out our new site, The Lyons Share. We are currently commemorating our 1-Year Anniversary with our BIGGEST SALE EVER for a limited time. Therefore, there has never been a better time to reap the benefits of our risk-managed approach. Thanks for reading!

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#$^VIX #$^VXST #$XIV #$VXX #$SPY #$^GSPC

Volatile Volatility

By any number of metrics, the stock volatility market just experienced its most spasmatic episode of all-time -- what does it mean for traders and investors?

The stock market events of the past week certainly qualify as one of those memorable episodes in the annals of Wall Street, even for those of us with decades of time in the grind. And when it is all said and done, this particular set of circumstances will be remembered as a volatility event.

Yes, many observers are rightfully focused on the events surrounding volatility-based exchange traded products. Whether they were the genesis of the past week’s market action or merely added fuel to the fire, there is no doubt that they played a significant role. And as many folks have warned, this enigmatic slice of the trading world has now undergone the reckoning (or the start of it) that has seemed all along to be its inevitable fate. We’ll let others opine further on that subject, though.

The focus of this post is the extraordinary (and, of course, not unrelated) action in the spot volatility market and the associated metrics. These tools, e.g., the S&P 500 Volatility Index, or VIX, and other derivatives, can serve as valuable stock market indicators, especially as it pertains to sentiment. They are particularly helpful when registering extremes like they did yesterday.

We’re going to take a look at 3 such examples of historic readings from the volatility market. The first comes from the VIX itself which soared yesterday by more than 100%. That was the first time in the history of the current iteration of the VIX going back to the early 1990′s that it actually doubled in one day. In fact, there have been just 3 other instances of even 50% daily jumps. This was not your ordinary volatility spike.

The 2nd example of yesterday’s historic day in the volatility market involves action in the term structure of the market. Specifically, we are looking at the relationship between the 9-Day S&P 500 Volatility Index, ”VXST”, and the 1-Month “VIX”. Typically, when traders get nervous, the will bid up the near-term vol instruments faster than the later-dated ones. And when the relationship gets extreme, i.e., when the closer index moves above the longer-dated one, it can be a sign of excessive fear, and a potential harbinger of an approaching stock market bottom.

You can say that yesterday’s vol term structure registered an extreme “fear” reading. That’s because, not only did the VXST:VIX ratio climb above 1.00 -- it hit 1.59. That smashed the prior record high reading of 1.41, going back to the inception of the VXST in 2011. That is some fear right there.

Lastly, since we are talking about volatility in the markets, and about the volatility market itself...let’s take a look at the volatility of volatility. Yes, even the VIX has its own Volatility Index, known as “VVIX”. As it implies, the VVIX measures volatility expectations on the VIX.

And judging by yesterday’s reading, volatility expectations for volatility have never been higher, as the VVIX came in at an unprecedented 177.34 reading.

So what does this epic episode in volatility mean for investors? Well, as we mentioned, when these types of volatility metrics get elevated, it can be a signal of heightened fear on the part of stock market participants. And as Warren Buffett once said, it is wise to be “greedy when others are fearful”.

Is that the case now? Or are the mechanics of the volatility ETP market distorting the sentiment picture here? We address that question a Premium Post at The Lyons Share as we take a deeper, statistical look at similar historical episodes involving the volatility indicators presented above.

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#$XIV #$^VXST #$^VVIX #$VIX #$VXX #$SPY #$^GSPC

The Astonishing Story Behind What Really Happened to XIV

Date Published: 2018-02-6 LEDE Hello, all. This is Ophir writing. During the market's closing hour on Monday, February 5th, some sort of "flash crash," likely triggered by margin calls, attacked the CBOE Volatility Index (INDEXCBOE:VIX), also known as the "fear index." What was a bad day, turned into a never before seen move. Here is it:

Whatever it was, the VIX went from 17% to 37% in a matter of two-hours, or up 115%. That is the largest percentage gain in the VIX in one day ever recorded. Even then, while that is a huge move, it wasn't really market disruptive in any great way other than, the market had a bad day. But then the after hours margin calls came in -- and that was an unmitigated disaster for one particular instrument of interest to us: Credit Suisse AG - VelocityShares Daily Inverse VIX Short Term ETN (NASDAQ:XIV). DON'T LISTEN TO TV The reporters on television have no understanding what XIV is -- it is not a naked short bet on VIX. No, it is an investment in the core underlying principle of market structures, driven by positive interest rates, known as Contango. Remember, the XIV is the opposite of VXX, and the expected value of VXX is zero. Here it is, from the actual VXX prospectus:

This instrument is not a radical short trade, it is fundamentally an investment in an ETN that reverses the value of an investment that is ultimately expected to be zero, which made it so good, for so long, and would have for several more decades. WHEN A LINE BECOMES THE FOCUS A little detail in the prospectus of XIV is that, hypothetically, should it lose 80% of its value from the close, it would cause an "acceleration event." That means that if the XIV sunk to 20% of its value, it would go to zero and the ETN would go away (and start over later). Now, obviously, this had never happened to XIV before, but it's only a decade old. When scientists back-tested XIV all the way back to the 1987 crash and including the 9/11 terror attacks, they noted that even then, XIV would not have suffered an 80% decline in a day. But we have never seen such a market with so many naked short vol sellers as we have today. As a barometer, even as crazed as Monday was, here is how XIV closed:

Down 14.32% is ugly, but, it's just a day -- a bad one, but nothing really all that crazed. Then the after hours session happened, and the best anyone can tell, as of this writing, is that some firm (or fund) had to unwind a short volatility position due to a margin call. That meant they had to buy the front month expiration of the VIX futures, leaving the second month unchanged. That little detail is everything, because the XIV is an investment on contango -- when the second month is priced higher than the first month. This is a market structure apparatus -- we could call it "normal market structure." But, with a flood of buying to cover short front month futures, the XIV started tumbling after hours. At first, social media saw it as a buying opportunity. Then it started dropping faster. Then disaster struck. The XIV dropped more then 80%:

The financial press did its best to cover it, but after a 2 minute segment on CNBC, there was nothing left to say because of one major rule inside the XIV prospectus. Here it is:

In that fine print, it reads that if the value of XIV dips to 20% of the closing value (if it is down 80%), the fund stops. That is, since this trade, if done with actual futures contracts, can actually go negative, the ETN stops itself out at an 80% one day loss. This is why we investors use the ETN, knowing that a 100% loss is the worst that can happen, as opposed to the futures, where much worse than 100% loss can occur. And the greatest burn of it all As of Tuesday morning the VIX is down huge (of course it is), the market structure has held (of course it did), and XIV would be having a very good day (of course it would). But, worse --- it turns out, as far as we know (still speculation), while it's hard to swallow, that the unwinding was done by none other than Credit Suisse itself. Yes, the creators of the ETN had another concern, beyond the assets under management -- and here it is -- -- look at the largest shareholder.

Credit Suisse quietly became the single largest holder of the very instrument it created, and by a huge amount. So, as 4pm EST came around, a bad day in XIV, but survivable, became the death knell, because the largest holder, the XIV's custodian, panicked, and covered. But, Credit Suisse could not very well just sell millions of shares of XIV in a thinly traded after hours session, so it turned to the VIX futures market. It appears, as of this writing, that this has actually occurred. While Credit Suisse (the issuer of the ETN) has yet to comment, it appears that whatever this "flash crash" did, whatever margin calls were triggered after hours, the short vol trader was in fact the firm -- it unwound positions in a size that the market has never seen before, and that means that it looks like XIV is possibly going to some very, very low number -- like $0, low. It's with great regret that as of right now, we do believe XIV is, for all intents and purposes, gone, from a little rule hidden deep in the prospectus that no one gave much concern and that got blasted away when the top holder in the note was the custodian itself. It's a reminder that the real danger to a portfolio is not a bear market -- we recover from those quite nicely as a nation -- it's the delirium that happens when a bull market gets totally out of control and margin is used excessively in a spurt of just a few days. And by margin, we don't mean normal, everyday investors, we mean the institutions -- even the ones we entrust to be custodians of our investments. So that's it. XIV,likely would have done just fine after this moment in time in the market, will not be given that opportunity to recover. It has been blown out on the heels of yet another Wall Street debacle, which no one seems to even understand, yet. The author is long shares of XIV in a family trust. Please read the legal disclaimers below and as always, remember, we are not making a recommendation or soliciting a sale or purchase of any security ever. We are not licensed to do so, and we wouldn’t do it even if we were. We’re sharing my opinions, and provide you the power to be knowledgeable to make your own decisions. Legal The information contained on this site is provided for general informational purposes, as a convenience to the readers. The materials are not a substitute for obtaining professional advice from a qualified person, firm or corporation. Consult the appropriate professional advisor for more complete and current information. Capital Market Laboratories (“The Company”) does not engage in rendering any legal or professional services by placing these general informational materials on this website. The Company specifically disclaims any liability, whether based in contract, tort, strict liability or otherwise, for any direct, indirect, incidental, consequential, or special damages arising out of or in any way connected with access to or use of the site, even if we have been advised of the possibility of such damages, including liability in connection with mistakes or omissions in, or delays in transmission of, information to or from the user, interruptions in telecommunications connections to the site or viruses. The Company makes no representations or warranties about the accuracy or completeness of the information contained on this website. Any links provided to other server sites are offered as a matter of convenience and in no way are meant to imply that The Company endorses, sponsors, promotes or is affiliated with the owners of or participants in those sites, or endorse any information contained on those sites, unless expressly stated.

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Stock Market Decline Poses Little Risk to the Real Economy

The three-day slide in global equity markets doesn’t represent a significant risk to either the U.S. real economy or the middle market at this time. There has been an attention grabbing 1.2 standard deviation move downward in U.S. financial conditions, including housing and technology (see figure 1). Even so, policymakers tend to only take note when there is a greater than 2 standard deviation tightening in overall financial conditions.

Figure 1: Global Financial Conditions

At this point the stock market decline appears to be a function of the following:

An acceleration in global and U.S. growth has resulted in a quicker pace of monetary policy normalization by the U.S. Federal Reserve, with the risk of inflation rising above the central bank’s 2 percent target in 2019 and 2020.

Rising political risk associated with difficulties in government funding, lifting the debt ceiling and the risk to global trade linked to the Trump administration’s policy. The markets are beginning to consider the implications of the U.S. Treasury issuing more debt, and the reality of what may be $1 trillion in annual operating deficits starting perhaps as early as 2018.

Reassessment of risk appetites by global investors and the unwinding of a consensus trade linked to shorting volatility. It will likely take a number of days to completely unwind trades linked to that consensus strategy. While this is a highly technical and isolated problem that is creating noise across equity markets, it does not necessarily imply a premature end to the current business cycle or the longer-term bull market in equities.

The shift away from human trading to algorithmic trading strategies was in part responsible for the decline of nearly 1,000 points in a span of about 10 minutes on February 5.

From an industry perspective this will likely have little impact beyond select financial institutions and the private equity space.

We anticipate that there will be more market disruptions along these lines going forward as global central banks unwind their unorthodox policies and reduce the size of their balance sheets to more manageable proportions.

#$SVXY #$XIV

The Astonishing Story Behind What Really Happened to XIV

The financial press did its best to cover it, but after a 2 minute segment on CNBC, there was nothing left to say because of one major rule inside the XIV prospectus. Here it is:

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