by Steve Claussen on November 16, 2009
The popular CBOE SPX Volatility Index (VIX 22.93% -0.43) is down again today on the market’s move higher. We have warned and attempted to inform our customers about some of the
risks and unique characteristics of the VIX in prior blog entries. Here is one more.
Each day, the VIX derives its value from the interpolated implied volatility surface of the midpoint of 30-day options in the SPX. The VIX index settles its options on the Wednesday morning that falls 30 days prior to the actual expiration of SPX options. This is the only day that the VIX is the actual 30-day measure of LAST TRADED implied vol. Every other day is a market estimation of an interpolation.
Because of the nature of the settlement, typically there is huge volume in the SPX options on the expiration morning of the VIX options, this is called the SPX carpet bomb, where VIX participants buy or sell every out-of-the-money strike in SPX to replicate the exposure to volatility in SPX that their expiring VIX contracts provided. This carpet bomb can produce huge swings in the VIX calculation from the prior day’s closing estimation of the index. The bid-ask width of SPX options in VIX index points can vary but is typically around 3 points.
This means if the settlement of the VIX occurs predominately on the bid side of the SPX options because of carpet bombing sellers in the SPX, the VIX could move from the prior day’s midpoint down 1.5 points or more! If all these offers move the bids lower, the impact could be even greater. If this seems complicated and full of uncertainty – it is – especially now that the VIX index itself is trading with an elevated volatility. The current 30-day historical (actual) volatility of the VIX is currently measured at more than 100% volatility.
The VIX is a very non-standard contract that is especially complicated and not for investors who simply want to have exposure to an increase or decrease in the volatility level. Regular options can provide that type of exposure.
Photo by Picture Perfect Pose
If you enjoyed this post, make sure you subscribe to the OptionsHouse RSS feed!
Tagged as:
CBOE SPX Volatility Index,
SPX,
SPX Carpet Bomb,
VIX
by Steve Claussen on November 2, 2009
How do we tell if this morning’s bounce is more than a
Dead Cat Bounce?
Often times after the market experiences a sudden out-sized drop like Friday’s frightful 250-point drop in the Dow, the next trading day the market bounces back. This happens almost in a knee-jerk response since many traders figure stocks are on sale.
This is why it’s important to remember how markets work.
It is a dynamic balance of supply and demand. When the demand grows relative to supply of stocks the price will typically rise. When the demand for shares is scared away, and lacking, the supply wins and share prices typically fall.
My point here is even if this morning’s rise is only fueled by a Dead Cat Bounce, if that is enough to turn scared demand into slight buying interest, the lack of liquidity of the market could turn a bounce into something more meaningful for at least a day when coupled with an economic “excuse” to buy stocks.
Add to any perceivable bounce the fact that 30 minutes after the opening we received a Pending Home Sales rise, a construction spending uptick and an ISM manufacturing Index showing a better than expected 55.7 reading. These economic catalysts seemed to boost a fragile bounce into a better than 1.5% gain in the market averages.
With the VIX up toward 30% however, the implied volatility surface is telling us to expect more dramatic movement each and every day for the near term.
Photo by MikeBlogs
If you enjoyed this post, make sure you subscribe to the OptionsHouse RSS feed!
Tagged as:
Dead Cat Bounce,
ISM manufacturing index,
Supply and Demand,
VIX
by George Ruhana on October 30, 2009
As oil broke above $80 on Thursday, I went and looked at ConocoPhillips (COP) and Exxon Mobil (XOM). They are an interesting case study in two companies who basically do the same thing, but their debt levels change how their stocks behave. I thought this example was interesting because many times people think of COP and XOM interchangeably, when they actually have different characteristics.
Of course, COP and XOM are very correlated, but if you look at both stocks over the last couple of years, you see that COP has been much more volatile than XOM. They both peaked in 2008 at about $96. However, when oil prices sold off and corporate debt was viewed as risk, COP sold off much harder than XOM. COP has a one-year low of $34.12, and XOM has a on- year low of $61.86.
Why would this happen? COP carries about $30 billion in debt, while XOM carries about $9 billion. This is a big difference because XOM has an EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) of more than double COP. Basically, COP has triple the debt and less than half the earnings.
Equity holders get whats left after interest payments. That means when oil prices are high, COP shareholders will have more equity (interest payments are fixed, while revenue goes up significantly), but when they are low, there will not be as much for equity holders (interest payments are fixed, but revenue declines significantly). This is why COP’s underlying equity moves more than XOM’s around oil price changes.
Because of this, if you are looking to trade one of these stocks based on your views of the price of oil in the short term, I would expect COP to move more than XOM. The options market gets this, so COP implied volatility, and thus premiums, are currently higher than those of XOM.
Theoretically, if you thought oil prices were not going to move, you might choose to sell premium in COP, since it is currently higher than XOM. Conversely, if you thought there was going to be an exceedingly large move higher in oil, you might consider buying COP calls rather than XOM.
COP is currently trading at $51, and XOM is currently trading at $74. When oil was at its highs, both of these stocks traded near the same price. If you thought crude was going back near its previous highs, and the stocks would behave the same way they did last time, COP should have a lot more room to the upside as it moves to catch up with XOM. Please be cautioned, however, that in any of these scenarios, past performance of both stocks is not an indication of future results.
There are a lot of other oil companies out there that are more leveraged than COP. It is a huge company that is vertically integrated, where others are just in Exploration and Production and therefore really exposed to the price of oil.
Photo by selva
If you enjoyed this post, make sure you subscribe to the OptionsHouse RSS feed!
Tagged as:
Big Cap Oil,
Conoco Phillips,
COP,
Exxon Mobil,
Large Cap Oil,
XOM
by Steve Claussen on October 27, 2009
Many investors trade long calendar spreads as part of their arsenal of option trading strategies. A calendar option spread is created by the simultaneous buying of a call or put in a longer maturity (expiration date), and selling the same strike call or put, in a shorter dated expiration month, e.g. stock ABC: buying the February 50 calls and selling the November 50 calls on a 3-month calendar spread.
The standard risk disclosure with a long calendar spread is that risk is limited to the premium paid for the spread until the first (shortest) expiration date. After that first expiration day passes, the risk is the same as a long option. In standard options it would be extremely rare for a calendar spread to be able to be bought for a credit where the further out option costs less than the nearer term option. However, in the CBOE Volatility Index (VIX) contract this is not the case.
The VIX is actually a European-style cash settled option. Settlement of this contract is based on a complex formula found on the CBOE website. The unique characteristics of the VIX are extremely complex and the individual months do NOT necessarily have any relationship to each other. The options are priced off of a forward 30-day volatility curve. This means each month basically is priced off its own underlying. The November VIX is not priced off the cash index but rather the future value of 30-day implied volatility of the SPX for the specific morning of Wednesday, November 18.
The February VIX options contracts are priced on the future value of the 30-day implied volatility of the SPX on Wednesday morning February 17, 2010. This forward 30-day implied volatility is definitely not the same for these two dates! In fact, the November future volume is currently priced at 24.90%. The February future volume is priced at 27.30%. These two different levels are the actual underlying for those options. It is the same as if the options have totally different stocks that they were based on.
This is why OptionsHouse does not treat calendar spreads in the VIX as a spread at all. The margin requirements will be the same as if you are selling a naked option with no protection, because that is in fact what you are doing. Buying the Feb 25 puts and selling the November 25 puts for a credit is not really a spread and not considered a bargain!
Be forewarned about the unique, complex risks associated with the VIX option contract.
If you enjoyed this post, make sure you subscribe to the OptionsHouse RSS feed!
Tagged as:
VIX,
VIX Calendar Spreads,
VIX option contract
by Steve Claussen on October 23, 2009
Amazon seems to be turning out to be the biggest beast of this earnings season! The online retail giant crushed the estimates, income surged 62%, and the company predicted 20-35% growth in revenue for the current quarter. The shares are responding dramatically, higher by 24%! (AMZN $116.28 +22.85)
This report is obviously warming investors today to the shares but the next quarter’s earnings report, which will include holiday sales becomes absolutely critical. Those earnings have typically been delivered after January expiration, so unfortunately the January 2010 options most likely won’t give exposure to the earnings release. We will have a macro sense of consumer spending but not what percentage of that retail traffic Amazon has captured! Option traders who would like to capture that future event will have to trade out in April expiration.
The OptionsHouse hotlist is seeing huge volume in the options, over 370,000 contracts trading today already! Looking at the OptionsHouse option chain we can see 4000 of the April 135 calls trading, predominately on the bid side, actually indicating selling interest. This may be the action of covered call sellers. Traders who are long the stock and overwrite an upside call take in a premium while limiting the upside to price appreciation above strike.
To learn more about the covered call strategy join the OptionsHouse weekly webinar series “2 Traders 1 Strategy” Tuesday, October 27, at 4:30 EST. Jared Levy, Senior Derivatives Specialist for OptionsHouse parent company PEAK6 Investments, L.P., and I will discuss all the ins and outs of this popular strategy. Click here to register.
If you enjoyed this post, make sure you subscribe to the OptionsHouse RSS feed!
Tagged as:
Amazon,
AMZN
by Steve Claussen on October 21, 2009
The VIX (VIX 20.33%) is hitting new lows as we are in the teeth of the earnings season. The measure of 30-day implied volatility derived from the options on the SPX is threatening to tick below 20% for the first time since August 2008.
At first glance this seems counter intuitive; earnings are often the most active periods for stocks. How can premiums for 30 option hedges be getting cheaper? To me the answer is found in the concept of correlation of stock returns. Correlation basically is the measure of how stocks move in relation to one another. If stock XYZ is down, in a highly correlated market, stock ABC will also likely be lower. During times of macro market crisis, stocks would tend to move in concert. The level of correlation in the market place during 2008 reached historically high levels. During this time we also saw the VIX spike to unprecedented levels.
Currently, however, and perhaps even more so during earnings season, the market is seeing a mix of winners and losers as companies announce their earnings. This variety of movement is more normal market behavior. Realized correlation has experienced a steady drop and is now closer to its historical average of below 0.40. The shorter dated implied correlation has also dropped from its elevated levels and if the market continues to trade in a more “normal” fashion, I would expect the VIX to continue to remain at levels that may appear cheap.
However, in trying to determine if the lower VIX indicates a time to buy there is another consideration. The implied volatility curve is positively sloped. This is apparent in the VIX futures that are trading at higher levels in December (VXZ 25.20%) and January (VXF0 26.25%). So, if the VIX index doesn’t increase as we approach the end of the year, it is actually decreasing from where it is predicted currently.
If you believe the market will continue to move toward normalcy in trading patterns, the lower VIX would not necessarily be an indication that it is time to buy. If you think our recovery is doomed to fail however, the lower implied volatilities we are seeing may appear to be a bargain.
If you enjoyed this post, make sure you subscribe to the OptionsHouse RSS feed!
Tagged as:
VIX
by Steve Claussen on October 14, 2009
The CBOE SPX Volatility Index (VIX) is now below 22.5%, reflecting the downward-sloping volatility skew curve. As the market goes higher, those upside S&P 500 Index (SPX) calls that had lower implied volatility valuations are a larger piece of the volatility matrix in the calculation of the VIX.
My source in the SPX pit is reminding me of the huge open interest in the October 1100 call strikes. More than 96,000 contracts are open. Assuming dealers and market makers are predominately short these options, any move higher approaching this strike will likely be exaggerated due to these dealers hedging the short gamma from this position. This creates conditions ripe for a short squeeze. Every percent higher the market rallies means more stock needs to be bought. Potentially, 1% moves could turn into 2% moves!
If you enjoyed this post, make sure you subscribe to the OptionsHouse RSS feed!
Tagged as:
SPX,
VIX
by Steve Claussen on October 13, 2009
Intel (INTC) earnings were one of the catalysts for the July rally. Given the response of the e-mini NDX futures to the release this evening we may get
déjà vu all over again. The futures are higher by almost 1%, indicating a positive start to tomorrow’s trading.
If you enjoyed this post, make sure you subscribe to the OptionsHouse RSS feed!
Tagged as:
earnings season,
INTC,
Intel,
Nasdaq futures
