The 6/10 “Momentum Flash Crash”

6/10/17 was a very strange day in the markets. There are plenty of places to read about the causes (here for example). Essentially tech led a very nasty volatility move up in the middle of the day. Whats really strange is that this happened just as the VIX hit ~25 year lows and the S&P500 hit all time highs around 2445. You can see the highlighted point below.

Here is Amazon stock chart as an example from Business Insider:

Screen Shot 2017 06 09 at 3.14.02 PM

 

This to me is showing how volatility and stock price are decoupling. From peak to trough the VIX moved up 27% in just a few quick hours, and closed ~+5%.  The “NASDAQ VIX” (symbol VXN) was up over 30% and closed there. You can see in the chart below how large and fast that move was.

Yes, the NASDAQ index was down 2.5% for the day, but the S&P500 was dead flat.

I think this is a sampling of whats to come. Major volatility moves relative to actual index price moves.

Someone Says Volatility Doesn’t Measure Risk

Notes from:

Volatility: A Misleading Measure of Risk

Pertinent when the VIX just hit low 10’s.

Michael Lebowitz says that there is a huge chasm between perceived risk (which if you go by VIX is 0) and reality. He like many others blames the Fed. It should be noted that hes selling “Financial Survival Guides” here. That should clue us in on what is to come in this note…

First, he includes a great quote from Chris Cole of Artemis:

“(volatility) is the difference in the world as we imagine it to be and the world that actually exists.”

The author then goes on to say that implied volatility “has been abnormally low more often than not” since 2008. “Currently implied volatility is at a level that has only been experienced 0.22% of the time since 1990 and is almost half of its longer term average.”

My issue with this is that implied volatility is the estimated volatility of the underlying price. You cannot just say “low” implied volatility. It has to be in relation to something – in this case implied (estimated) volatility has to be compared to realized (actual) volatility.

Here is their VIX chart:

Lets use the last 12 months as an example. Realized volatility is ~9%. Thats under the red line that he draws on the chart above.

This chart shows more:

My point is you can’t just say “implied vol is abnormally low” you have to compare it to realized.

Second, you could also easily make the case the markets in 1990 were totally different than they are now, for better or worse. For one, VIX options didn’t start trading until 2006. Markets are now all electronic and connected globally. Information spreads like never before. Dodd Frank, CCAR and the like have changed the risks banks can take, this is particularly an issue for hedging as they are required to have risk hedged in the event of a 20-30% equity market moved.

The reasons the author sites for this “low implied”:

  • The Fed & its easy money
  • Corporate buybacks
  • Volatility Trading
  • “Passive Mentality”

Strangely he mentions the falling dominoes the same day Martin Armstrong did. Coincidence? Someone copied someone…. I suppose his conclusion is to expect a major volatility event but he just says:

“When the entirety of the current situation begins to more fully reveal itself, investors are likely to find that the difference between esoteric measures of implied volatility and their very tangible perception of reality could not be more different.”

I think to find out how to hedge this coming cataclysm you have to sign up for their newsletter.

 

Remember – Volatility Mean Reverts

Its something everyone loves to say when the VIX is  at 20 or 30, heck even 15. Yesterday we hit lows in volatility not seen since 2007.

The spread between realized volatility (SPX realized is ~7) and 3 month SPX implied has come in quite a bit as per Bloomberg. In April realized was ~7 but implied was ~12. So from that standpoint, volatility is “cheaper” now than its been over the last few months.

Maybe its time to think about unwinding that short vol trade…

VIX lows

Trouble Comes When VIX Term Structure Inverts

There is a very good presentation from JPM here on VIX and VIX related products. One section that caught my eye was on VIX futures term structure inversion. The presentation is from 2012 – but the data from 1990 says that you don’t see major VIX spikes (over 40) unless the term structure in futures is inverted first. Also, the VIX was around ~20 before going to 40+. IE there aren’t many incidences (or any?) where the VIX is 12 today and 40+ tomorrow. Incidentally I checked August 2015, and the VIX hit ~21 on the Friday before the major spike to +40 (Monday).

Summary: When the VIX term structure inverts you need to be on watch.

JPM VIX futures term structure

 

PE to VIX Ratio = Market Emotion?

I hadn’t come across this idea before, its a few years old but interesting.

From Arrow Capital:

PE/VIX = market emotion: lately drifting in and out of complacency
We define 5 categories of market emotion gauged by  PE/VIX:

1) Crash – very high VIX and low PE,

2) Skeptical/Denial – VIX elevated and PE still low,

3) Realistic/Disciplined – Both PE and VIX within normal ranges,

4) Complacency – low VIX or high PE or both,

5) Mania – very high PE and low VIX.

Why Short Volatility Is So Popular

Hedge Funds in general have had a tough go the last few years. One segment that has had arguably the worst ride of all is Long Volatility Hedge funds. As you can see by the CBOE Eurekahedge Long Volatility Hedge Fund Index, its been ugly. While I don’t pretend to be a professional market technician, that chart is not pointing in the right direction.

CBOE Long Volatility Hedge Fund Index

If you look at all their “volatility” funds you can actually see tail risk is measurably worse.

CBOE Volatility Fund Index

Now, compare this to short volatility funds. If this was a stock you’d probably want to buy it. This chart makes it easy to understand why so many jump on the “short vol train to easy alpha”.

CBOE short volatility funds

Many attribute the lack of recent volatility to the “Central Bank Put” which was the markets general belief that any drop in prices would be met by Central Bank support.

The Fed has hinted  that it might start to reduce its balance sheet. That doesn’t mean the “put” is gone, but its not as sure of a thing. Much like the European Union, its still there, but its not so sure of a thing.

 

My point is – we’ve had a very consistent and stable world. Stock markets are at all time highs. Post 2008 investors could more or less know what to expect tomorrow. To me it seems like that tide is turning. Regimes are changing.

I think some of this risk will start to show up in the form of a higher “volatility equilibrium” closer to what we saw just after the 2008 crisis.

As a way of visualizing the chat below shows that we are currently in rough range of 10-15 VIX, with a floor of 10.For sake of argument lets say that was an average of 12.5. The volatility of volatility appears to have tighter range than say 2008-2012.

From 2008 to 2012 the floor was 15 and the average is clearly higher. Lets say for ease of argument the average was 20.

VIX equilibrium

I think this new, higher volatility equilibrium is somethign to keep a keen eye on as the results of any number of major shifts, for example:

  • Effects of “populism” and shifts out of EU
  • Trumps ability to “get stuff done”
  • Interest rate changes
  • Fed policy changes

 

 

 

US Volatiltiy Takes a Breather

The VIX is back under $14 this morning, but the European VIX (V2X) is not. To me it doesn’t now seem worth putting on any large positions with the elections coming up. Now that US volatility has come in quite a bit it doesn’t seem great risk/reward shorting it either. Cash is a position as they say.

V2X year chart

EU Volatility vs US Volatility

The V2X VSTOXX Index is based on the EURO STOXX 50 Index – like VIX but for Europe.

Compare the term structure of the V2X (top courtesy of Bloomberg) futures to VIX(bottom, vixcentral.com).

V2X term structure

V2X came into April with a 16 handle, so it is much more elevated than VIX at this time. As its so expensive to hedge in the EU I think this is turning traders to use the VIX as it is cheaper.  Couple that with the fact that yesterday was a EU holiday and volatility was sold hard. This is hinting that a lot of the hedging demand is non-US.

If there is an upset in the French election that would certainly hit US markets but not as hard obviously as EU. Keep in mind for there to be an upset one candidate would have to have over a 50% vote which seems very unlikely. My ignorant bet is that nothing final comes from next weeks election and that pushes the decision to May 7th. We would then see a selloff in volatility as traders have to roll out protection.

A Backward Contango

Despite a selloff in volatility land yesterday there is still a strange “backward contango” in VIX futures caused by the French Elections. In normal times you would see “backwardation” in the chart below (blue line). This means the April VIX future woudl have a lower price than May. However April is higher than may, again, most likely due to the French elections. This could work against you if you are using short volatility ETPs and with you if you’re long VXX or another long volatility ETP. Explained here and here.

VIX Contango

Currently according to the VXX website April futures are a very small component of the holdings. As May VIX futures prices are less than spot VIX (green line in the chart above) this means you might not collect on the “reversion” or decay of the futures to VIX. To me this means shorting VXX isn’t as juicy here as 15/16 handle VIX might imply.

VIX Futures Roll

XIV, the short volatility ETF has basically the same futures allocation. Again because of the weird VIX futures curve when you are buying XIV you are long mainly May futures which are less in price than spot VIX. I don’t think this is an advantageous product to use to short volatility at this moment because of this inversion.

XIV allocation

Short Term Vol Top In?

Without any new catalysts to push people into hedging its hard to see what ramps volatility higher here. Adding new hedges at this point is quite expensive relative to a week ago.

Many of the volatility ratios are starting to move back into their ranges. Below is a ratio of VIX to “Short Term” VIX which measures 9 day volatility.

Plus you know there are lots of dollars waiting to short this volatility spike – so when it starts to fade it’ll fade quickly.