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Has most of the drama played out?

 
Thursday, July 28th, 2011 | Vance Harwood
 

With Greece’s Euro problems successfully extended out a few more months, and the economy continuing to consistently send mixed messages, the focus of fear is the budget cap.  I’m thinking neither party has the stomach for the wholesale disruption of the Treasury’s affairs.   I wouldn’t be surprised to see one more major upswing in the VIX, but right now the prospect of a happy ending plus a favorable signal from Mr Bollinger, has me back in the market with VXX $24 September puts again (at $3.10).

VIX at 2 sigma Bollinger, click to enlarge

Posted in VIX | 2 Comments »

A Brief History of Fear—VIX Over the Last 25 Years

 
Friday, March 16th, 2012 | Vance Harwood
 

One of the scariest things about market panics is their unpredictability.  All of us remember the dark days of 2008 and 2009, not so many the October 1987 crash.   For me, both of those crashes carried the same sense of disruption—the feeling that things would never be quite the same again.

I’ve been looking at the history of volatility, because it’s clear to me that volatility spikes are a big danger in the inverse volatility investing that I’m been doing.   Shorting VXX, or being long XIV is great while we are in a bull market, but things can get very ugly in a hurry.   The chart below shows a history of volatility, starting in January 1986.  Neither the VIX, or its predecessor VXO existed at that point,  the original index started in 1993, but the CBOE has projected the old style VXO index back to that year.

Volatility 1986 through 2011, click to enlarge

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I’ve never looked closely at the original VIX index, which is now called the VXO.   The VIX methodology we now use was put in place in 2003.   The chart below shows the two indexes during a fear spike in the fall of 1998.   The two track each other closely enough that for normal and semi-normal situations they look comparable.

VXO vs VIX August 1998, click to enlarge

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Below, I have zoomed in on the October 1987 and the November 2008 fear spikes.

October 1987 volatility spike, click to enlarge

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Fear in November 2008, click to enlarge

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Looking at these two monumental spikes, there doesn’t seem to be anything unusual about the run-up.  Nothing in the data suggests that a massive spike in volatility is on the way.

For more information, and access to the the raw data that I used see the CBOE’s microsite on VIX.

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Posted in all, VIX | 5 Comments »

Fear set to fade?

 
Tuesday, July 19th, 2011 | Vance Harwood
 

I  keep an eye on the 6 month chart of  VIX index’s relation to its Bollinger bands when I’m thinking of making a volatility trade—even when the trade I’m contemplating is a non-VIX related security (e.g., VXX, or XIV).   Of course there is nothing iron-clad about it, but as an objective measure I consider VIX touching/near touching  its 2 sigma lines to be an indication that the current phase of the market is ending.

6 month VIX chart with Bollinger bands, click to enlarge

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I bought $24 strike September VXX puts today at 2.83.   With VXX you tend to not get as much mean reversion as $VIX, but the puts benefit from the typical contango that VXX suffers from.

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Posted in VIX | 16 Comments »

Backtesting of VZZB—Barclays’ replacement for VZZ

 
Monday, July 18th, 2011 | Vance Harwood
 

Barclays didn’t waste any time replacing its recently terminated VZZ ETN.  The new fund, targeted at leveraged long performance relative to medium term volatility appears essentially identical to VZZ except for its new inception point.  Rather than follow daily percentage moves, Barclay’s inverse and leveraged funds behave like actual short or 2x leveraged position when they are created.   The good news with this approach is that there is no path dependencies or compounding effects.  The bad news is that the “participation rate”, or effective leverage changes over time and it usually isn’t in your favor.    Right before VZZ was terminated its leverage was running in the 3.55X range, quite a bit hotter than its 2x inception rate.  For a discussion on this effect on inverse volatility funds (XIV, IVO, XXV), see this post.

I backtested the new VZZB against its newly departed sibling VZZ  in the charts below from  late 2005 with the VIX index for reference.  I included short histories/ backtests of the other two leveraged volatility ETNs—TVIX and CVOL in the first chart.   TVIX is a 2X daily percentage leveraged ETN based on the same short term  index that VXX uses, whereas CVOL is based on a 2X daily percentage of a rolling combination of 3rd and 4th month volatility futures with a variable short component on the S&P500 thrown in.   I have only backtested CVOL back to the beginning of 2010.   TVIX goes off the chart very quickly—it suffers severely from contango based erosion of its price.

VZZB backtest-big picture, click to enlarge

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Focusing on the VZZ / VZZB results, there is nothing too surprising about the VZZB.  Pretty much the same shape, just shifted up.   I think this chart suggests an overly optomistic picture on VZZB because contango was not as severe before 2008.    I expect VZZB  to last more than the 7 months that VZZ lasted  but I doubt it will take longer than 1.5 years before it hits its $10 termination value.

VZZB-backtest, click to enlarge

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VZZB press release

VZZB prospectus

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Posted in all | No Comments »

Scary Market

 
Tuesday, July 12th, 2011 | Vance Harwood
 

I think the big picture on the overall economic situation is pretty scary right now.   The factors I see, in increasing scariness:

  • The debt limit drama in Washington is probably only a side show, but each side might believe that a bit of a crisis might help their cause.
  • The USA economy is cooling off a bit, with the companies mortally wounded by the recession nearing their death rattle  (e.g., Borders, Blockbuster, Sears), and ones with damaged strategies (e.g., Cisco, HP) moving into layoffs and other cost cuttings
  • The breakdown of the Euro.  Previously I posted that I think it is a matter of when, not if some members of the Eurozone will be forced to default on their Euro-Bonds,  and resurrect their national currencies.    Greece appears to be the first one that will go.    The big question is whether Italy and Spain will topple too.   I suspect these two will be able to stay in the Euro club, at least for a couple of years, but until things settle out I think there will be a lot of uncertainty—which will be bad for the market.
From a market standpoint, Mark Sebastian, at option pit, has posted that this pullback looks different from the June correction.   This time the major players are buying premium, not selling it like they did in June.  He sees this as a setup for a major sell off.
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I have closed out my XIV positions and battened down the hatches.  Most likely this storm will pass without a major correction, but right now I’m much more comfortable being on the sidelines.
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Posted in all | No Comments »

Guggenheim—yield with less interest rate risk?

 
Thursday, March 1st, 2012 | Vance Harwood
 

If you are looking for low risk yields above 1.5% per year, there aren’t many attractive candidates.   Stocks seem risky, and if you believe that interest rates are going to go up in the next couple of years then bonds look risky too.

Using IEF, Ishares’ 7 to 10 year US treasury bond fund as a example of risk—it  is currently yielding about 3%.  Sensitivity to interest rates in bonds is quantified by a attribute called duration, which indicates how much a bond’s current value would change if interest rates changed by 1%.  IEF’s duration is 7 according to Fidelity’s key statistics page (no sign in required).  If IEF’s blend of  treasury bonds goes from yielding 3% to 4% its value would drop by 7%—wiping out more than two years worth of interest.

Bond funds like IEF continually roll over their bonds so that they keep a consistent duration.  Guggenheim, on the other hand has created a set of  bond funds with fixed end dates.  Their duration with decrease overtime until they terminate..   They currently offer end dates of  2012 (BSJC) through 2015 (BSJF) for their high yield corporate bond funds, which currently are yielding annual dividends of about 3% to 4.3% and durations ranging from 1 to 2.   Hmmm almost too good to be true…

So what’s the catch?  The catch is the credit rating of the bonds in the fund.   All the fund’s holdings are rated BB+ through CCC-, below investment grade—junk bonds in industry parlance.  With Guggenheims’  BSJC through BSJF series you have exchanged most of your  interest rate risk for default risk.   These funds reduce their risk by investing over a broad range of sectors (e.g., financials, cyclical consumer), and by investing in quite a few different bonds (37 currently).  There isn’t much history, but my suspicion is that these funds will hold up well—unless we have another 2008/2009 style financial meltdown.

BSJD info    Family Prospectus as of 2-Mar-12

Disclosure:  currently holding BSJD, bought at $25.80

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Posted in all, dividend | No Comments »

A death in the family—VZZ

 
Thursday, July 7th, 2011 | Vance Harwood
 

As of next Monday, July 11th VZZ, Barclays’ iPath® Long Enhanced S&P 500 VIX Mid-Term Futures will stop trading.  It is already a zombie because its termination price has already been set at $10 even.  XXV, the other volatility zombie continues to trade on average 100,000 shares a day—maybe people are content to just beat T-bills and not much else.

See these posts for more details on the VZZ termination.

I’ve updated my Volatility Tickers to reflect VZZ’s imminent demise.   By my count there are now 14 volatility Exchange Traded Products (ETP).
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Posted in all | 4 Comments »


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