On January 6th, 2011 I posted a blog about volatility in the US equity markets (click to see that blog post). The short version of that post was that volatility as indicated by the $VIX was cheap on a historical basis. I suggested that readers get long volatility either through $VIX futures or the VXX ETF. I know that the VXX is called a "widow-maker" by many and that deserves a separate conversation (I will summarize briefly at the end of this post).
So what has happened to volatility since Jan 6th? Well as of the closing price on Friday, $VIX is down 9.2%, the 10-day avg of the $VIX is down 1.5%, and the ratio of 10-day ATR / 10-day $VIX is down less than 1%.
Translation … the market is pricing the actual volatility in the S&P 500 (as represented by the SPY ETF) at basically the same level as it was at Jan 6th. Nothing has changed.
I am going to lift the following discussion right from page 26 of my free January 16th newsletter (click here … Download January 16, 2011)
I wanted to talk a little bit about the how unprotected the market is right now in terms of put protection. My Put/Call Ratio chart on the next page highlights that this ratio is at levels usually seen in conjunction with market tops. When I dig a little deeper and look at the amount of puts outstanding on the SPY ETF I am quite surprised by the tiny levels. At a SPY price of $130 … the value of call options at next week’s expiry is $539 million vs, $7 million for the value of puts (as per www.optionpain.com). In February, the SPY call option value at the same $130 price is $305 million and for put options $6 million.
If you say that is fine, market players have protection just under current prices … well not exactly. In February, you have to go all the way down to the $123 strike price before you get put option values greater than $200 million. In January, the $127 strike price has only $29 million of outstanding protection.
The point I’m trying to make is that any weakness in the market will not be met with steady hands that have lots of insurance/protection in place to protect the values of their portfolios. This is what causes potential air pockets for markets.
Here is that put/call chart as of a few minutes ago.
Nothing has changed really from the first week of the year … I would have to summarize that the equity market is pricing in a solid 4th Q earnings season and based on the price of volatility and the amount of put protection apparent in the SPY ETF, people are betting for a good season and nothing less will do.
Looking ahead for a what if scenario is never a bad thing.
I have been trading the VXX since my Jan 6th post … to say that it has met my expectations would be a half-truth. I buy and sell it mainly intra-day, playing the extremes that I see in the market. I know from my own experience and research that I have done on it that it does a very poor job on tracking $VIX.
I would suggest to readers that they be careful in trading the VXX … I plan to get heavier involved and take it overnight on trades once the daily trend line is broken. I would suggest that people do the same.
If you google VXX you can find several impartial studies on the VXX … here is one such analysis … www.donfishback.com
Cheers … Leaf_West