This week CBOE expanded their selection of weekly options from 31 to 35. The symbols added this week (expiring November 5th) are: IBM PCLN RIMM SLV. All these except PCLN (Priceline.com Inc.) have previously been on the list at some point. For more on the CBOE’s weekly options see here, or see my guest post in the August issue of the online magazine: Expiring Monthly: The Option Traders Journal —a publication I strongly recommend.
The Archives
Browse the content below to find what you're looking for.
XXV: Dancing the contango—without getting mugged
Thursday, December 29th, 2011 | Vance Harwood
Update
I do not recommend XXV. At its current price of around $30/share it does not deliver the sort of performance you would expect an inverse volatility security to deliver. This security can go no higher than $40 per share and can only get there slowly. See this post for more information. If you want to be short volatility use XIV or IVOP.
Original Post
The inverse volatility ETN XXV has gained over 50% in the 70 trading days since Barclays introduced it. However, far from lighting up the investment community the interest in XXV has been moderate, with an average daily volume in October of 231 thousand compared to 31 million for VXX—its inverse.
If you’ve been paying attention, you know that VXX ( which not surprisingly has lost over 50% in the same period) suffers from two major maladies:
- The VIX index, on which the VXX is based (via volatility futures) tends to drop towards the 10 to 15 range when the market is going sideways or up. There is no prospect for sustained, long term growth.
. - The VXX ETN must continually update its portfolio to include more longer dated futures and fewer short term futures. Longer dated volatility futures are almost always more expensive than short term, so the VXX operators are continually buying dear and selling cheap. In commodities markets this higher price structure for longer dated contracts is called contango
.
With two strikes against VXX, why aren’t people buying XXV, or just shorting VXX?
If these two ETNs were people, VXX might be a depressed alcoholic artist that has occasional bouts of brilliance, whereas XXV might be an overperforming sales person that normally blows through sales quotas, but occasionally disappears for a couple of weeks and then calls asking you to post bail.
If you want to invest in XXV you should have a pre-disappearance sell strategy. XXV already has a doomsday $10 “termination event” stop loss built into it, but with XXV currently above 30 a loss limited to 66% or more is not comforting.
A trailing stop strategy is attractive, with perhaps a 2% trigger, but a key requirement for a stop loss order to work well is an orderly market when things are dropping. If the XXV price gaps down in bad times then a trailing stop order would not offer the protection it implies—potentially filling at a much lower price than 2% off its high.
Evaluating XXV’s behavior during the May 7th Flash Crash would be a great test—except XXV didn’t start trading until July 19th.
Not easily deterred, I synthesized an approximate XXV chart for all of 2010 using VXX intra-day high data. I used the intra-day highs, because that would map to the intra-day lows in XXV that would potentially trigger a stop loss order. I didn’t try to include the impact of XXV’s .89% yearly fee in my calculations.
VIX, VXX, and a synthesized XXV, Click to Enlarge
Comparing the chart of the actual XXV values (purple) against my synthesized chart (green) suggests this approach is valid.
The May Flash Crash and subsequent market correction would have dropped XXV to around 15, but would not have tirggered the $10 doomsday stop loss. The market uncertainty preceding the Flash Crash would have tripped a XXV position’s 2% trailing stop around April 27th, and the rising $VIX would have kept a prudent investor out of XXV until well after the volatility fireworks died down. In summary, a trailing stop type approach looks like good way to protect an investment in XXV.
This same analysis should apply for just being short VXX, however my broker rarely has VXX available to short, and with an IRA account you can’t sell equities short, so XXV is the best option for me.
Up a little, or down a lot?
Thursday, October 14th, 2010 | Vance Harwood
I believe that current market rally will continue for a while, however I’m pretty confident that there will be a pretty good correction at the end. Predicting when this will happen in the tough part. Monday I saw the opportunity to play it both ways. I bought SPY at 116.65, sold-to-open S117 calls expiring this Friday at .78, and for every call I sold bought three S114 puts expiring Friday at .27 for a net investment of 116.68.
If SPY continues its rally through this week to close above 117 , I will pocket a small $0.32 gain per share. If the market sags , but does not tank, my worst case loss is $2.68 per share at 114. If the market tanks my break even is 113.10 and provides $2 of profit per share for every point below that.
The tale of two rallies
Monday, October 11th, 2010 | Vance Harwood
SPY’s 2010 price path for the 8th of October is about 3 points higher that the 2004 trend top line, but that is consistent with 2010′s considerably higher volatility. Recently there have been articles noting relatively low trading volumes, but compared to the normalized volume in 2004 (which at an absolute level was about 3.5x lower) volumes don’t look out of line.
SPY 2004 vs 2010, click to enlarge
The rally that we are currently in started around the 31st of August. To me it has felt similar to the long rally we had starting in February 2010. No wonder. Both rallies started with SPY in the 105 to 106 range, and have tracked closely since then on a day by day basis–see below.
SPY rallies: Feb 2010 vs Aug 2010, click to enlarge.
If these rallies stay in sync then we would expect the next bear cycle to start right before Thanksgiving.
.
The “Sell Algorithm”, the Flash Crash, and Limit Orders
Thursday, October 7th, 2010 | Vance Harwood
The recent report from the SEC and the Commodity Futures Trading Commission on the Flash Crash fingers an automatic sell program executed by a “Mutual Fund Complex” as the trigger of the crash. Starting at 2:32 p.m. EDT on the 6th of May this program, referred to as the “Sell Algorithm” automatically sold short 75,000 E-Mini S&P futures contracts (approx 4.1 Billion dollars worth, equivalent to about 42 million shares of SPY) over the span of 20 minutes.
.
Presumably the goals of the Sell Algorithm included:
- Selling these contracts at as high a price as possible
- Not unduly disrupting the market.
.
Both of these goals were botched.
Both of these goals were botched.
.
I think a better name for the Sell Algorithm would be “Bonehead Algorithm”, because the designer, and presumably the review team that vetted it did not consider what a sell of this magnitude could do to the market. The Sell Algorithm was designed to limit the number of contracts sold to 9% of the volume the minute before, however there was no provision for adjusting its strategy based on absolute volume, price fluctuations or time durations. I can imagine there were big fights about whether the percentage should be 8% or 10%, but 9% won out.
It is widely reported that Waddell & Reed is the unnamed company in the report. When they executed a similar trading move previously, they used a more nuanced algorithm that did factor in price, time and volume—it took about 5 hours to sell 75K contracts. For some reason they ditched that approach in favor of this “improved” algorithm.
Waddell and Reed didn’t anticipate that their selling strategy would set off a trading frenzy between the market makers (mostly high frequency traders) in E-Mini S&P contracts. These traders primarily bought and sold between themselves during the initial disruption. The contract volume, which had been peaking at around 35K contracts per minute jumped into the 75K contract per minute range (see chart below). The clever Bonehead Algorithm responded to this jump in volume by upping the number of contracts it sold the next minute to 9% of the new volume number.
This increasing selling pressured the E-Mini S&P market down more than 5% in less than 5 minutes. This sudden drop triggered the Chicago Mercantile Exchange Stop Logic Functionality, and trading was halted for 5 seconds. Five seconds isn’t a long time, but it was enough for the E-Mini S&P 500 market to right itself and start recovering.
.
Unfortunately the effects of this drop were already reverberating through the entire market.
E-Mini Volume during Flash Crash, SEC report, click to enlarge
As the E-Mini S&P 500 futures were dropping firms that specialize in cross-market arbitrage took advantage of the gap between the E-Mini and equivalent markets (e.g. SPY, S&P 500 stocks) to lock in risk-free profits. For example they bought E-Mini contracts cheap and sold SPY until SPY’s price dropped to the equivalent level as the E-Mini.
.
This process transmitted the E-Mini shock across all of the S&P 500 stocks—which comprise well over 50% of the total market capitalization of the US stock market. In response institutional buyers and sellers widened their spreads, switched to manual only trading, or withdrew from the market completely as they tried to understand the cause of this rapid decline.
The remainder of the Flash Crash was like a major power blackout. As more and more market participants dropped off-line the remaining demand concentrated on fewer and fewer market makers. Trading on some equities collapsed. In those cases all that was left were the “stub quotes”—the never intended to be used bid / ask prices that market makers use to prevent a bid price of zero, or an infinite ask price. These stub quotes were as low as $0.01 and as high as $100,000.
Some institutional lessons learned:
- Volume does not necessarily mean liquidity. High frequency traders can generate high volumes without providing true price support.
- Trading halts need to be coordinated across the entire market. Allowing some exchanges to stay on-line while others halt trading creates overloads that will likely result in disorderly pricing.
.
For individual investors I think the primary lesson from the Flash Crash is to use “stop loss” limit orders very carefully. If they are placed too close to normal prices you will get sold out during normal fluctuations, if you set them too low you run the risk of being blown out at a lousy price by a market disruption.
If you are going to use stop loss orders I think the best approach is to use a trailing stop approach, where the limit is automatically raised as the underlying goes up. If you use stop loss orders you should think twice before using the stop loss “market” order. These orders become market orders once the limit price is breached. If the market is disorderly you might get a fill that is well below your limit price. Instead you can use stop loss limit order. These specify a minimum price that you will sell at once the limit price is breached. If you set this number slightly below your stop loss price you will probably get a fill if the market is orderly, and it will offer some protection against being screwed by a disorderly market.
Follow Six Figure Investing
