Almost There
VIX index at an interesting crossroads
If you look at a chart of the VIX index, a rough estimate of implied volatility, it looks very much like a broken stock. But it isn’t a stock; it has no fundamentals. It is most closely related to sentiment and even though sentiment comes in extremes, it is always cyclical: a very low level may go lower, but at some point it will come back. The levels clearly indicate complacency, extreme complacency. The option flow I have seen confirms this: I have seen an overwhelming supply of options. From selling upside calls to downside puts, no one seems to want to own options here.
The first wave of selling comes from those that are long options and sell because they are losing money. The second wave comes from those that short options, thinking there is money to be made because the market of stocks will move little. This second wave is where leverage in the market is built up. This is where I think we are now.
What I am waiting for from here is a pick up in the VIX (I don’t really use the VIX, rather baskets of other options; but they are highly correlated and they are confirming each other). When it begins to turn up, that to me is a signal that some very smart buyers who have good information are beginning to buy options. I started to see it yesterday, but so far today the VIX has trailed back off. This signal is one of the best I use and is almost always a bearish one. It won’t catch the top, but it is good at catching a sustainable trend lower. We are almost there.
John Succo
No positions in stocks mentioned.
John Succo is the Chief Investment Officer and co-founder of a New York-based hedge fund concentrating in derivative strategies with approximately $175 million under management (the "Fund"). Prior to his current role, Mr. Succo was head of risk and a member of the investment allocation committee at Alpha Investment Management, a New York-based fund-of-funds. Prior to that, Mr. Succo was an options trader and head of derivatives at various Wall Street firms.
AND A FOLLOWUP
Da VIX
More on John's volatility thoughts.
Adding to John’s comments on the VIX…over the past two months, the VIX has been stuck
in under a 5-point range. During the history of this indicator, such a small range over such a sustained period is quite unusual, as less than 5% of the days have shown such a small range over the prior 42 days. For those days that showed the smallest range in the VIX over the previous 42 days (the bottom 5%), the next 42 days showed a higher average range more than 85% of the time. This suggests that it is likely that we will see a pickup in volatility (as measured by the VIX) sooner rather than later.
If we look at the VIX’s range over the past two months as a percentage of the VIX itself, then our current situation has been the least volatile in history, except for one other period – mid-July 1997. During that time, the VIX was also stuck in a very tight range heading into the summer months, with a slightly smaller range than the current one. The result was a small rally before the market declined into August and September. The market eventually recovered during the latter half of September and October before the crash in October of that year. Interestingly, the next least-volatile period was early June 1989. The result of that was a market decline throughout June, then a recovery during the rest of the summer – then a mini-crash in October of THAT year as well. It would be ridiculous to leap to the conclusion, based on these precedents, that we will decline for a month or so, recover, then crash in October. But I do think it’s reasonable to expect an increase in volatility over the coming months – and as John states, an increase in volatility is normally associated with declining markets, not rising ones. |
