What the Market-Makers see now
(Used with permission)
The vertical lines in Figure 1 are daily forecasts of possible ranges of the VIX index in the coming three months derived from the way market professionals use VIX derivative securities to hedge their market investment exposures. The heavy dot in each vertical marks the Index at the time of the forecast.
The green verticals designate when the forecasts are nearly all to the upside above the current index. The June perturbation illustrates typical VIX behavior.
A longer-time perspective is created from the same data by taking once-a-week samples from the past two years, as in Figure 2:
(Used with permission)
The present index is at low levels of the forecast range indicated by a current Range Index (RI) of 3, which measures the percentage of the whole range forecast that is below the current index value. The other 97% is to the upside, but that is not unusual.
The small blue "thumbnail" picture shows where daily RIs have been in the past five years.
We use the RI to segregate actual "price" changes in the VIX Index, as reported daily, to see how it behaves at different levels of prospective upside to downside forecasts. That is shown in Figure 3, where the five-year average of changes in progressively longer time periods is measured in the horizontal blue row of data.
A RI of 3 is the equivalent of a 30 to 1 upside to downside situation, and is indicated by the magenta count of the number of times that RI or more extreme (lower) has occurred in the past five years. As the "holding period" after the forecasts increases weekly (the yellow footers to each column), the percentage increase in the VIX index also rises.
An easier-to-evaluate display of these changes is to be had in Figure 4, which converts the simple percentage changes into a more meaningful CAGR, or annual change rate.
The critical nature time plays in the VIX picture is evident here. Most of the change rate opportunity is present quickly, but even at longer periods, the size of changes at an annual rate is impressive.
But how easy is it to capture them their being so dependent on good timing? These tabular displays all measure from the date of the forecast, not from any common calendar date.
A number of ways exist to evaluate their capture-ability. One is to see what proportion of the forecasts at each RI level produces profits at each longer holding period. That is what Figure 5 shows:
Well, at most RI levels, the positions are an odds-on proposition, although not a very enticing one where only two winners out of three are among the better scores. Any RI above 25, a 3 to 1 RWD:RSK proposition is at best a coin-flip, and the average is an odds-on loss.
The average losses could readily be seen in Figures 3 and 4.
Another means of discriminating is to look at the payoff extremes known to be present. They are shown in Figures 6 and 7:
Please remember these are simple percentage changes, not CAGRs, which would be even more extreme.
So it pays to be highly selective with the VIX in picking an entry time/price.
A perhaps more instructive selection guide might be the ratio of profits from each stratum of forecasts to the losses from that same set. Figure 8 makes that calculation, shown times 10 (winnings to losses), to provide a decimal fraction in limited display space.
Now looks like one of the better times to play this high-risk, high-return game. But you better have your big-boy/girl pants on if you decide to do it. Your choice; don't come whining to me. Thanks will be enough if the "spin of the wheel" comes up right.
By the way, the VIX Index cannot be played directly. There are a number of related securities that can be used - none of them are anything more than a buy to be sold; no buy-and-hold approaches are suitable. Keep alert if you do and don't get greedy.
Additional disclosure: Peter Way and generations of the Way Family are long-term providers of perspective information (earlier) helping professional and (now) individual investors discriminate between wealth-building opportunities in individual stocks and ETFs. We do not manage money for others outside of the family but do provide pro bono consulting for a limited number of not-for-profit organizations. We firmly believe investors need to maintain skin in their game by actively initiating commitment choices of capital and time investments in their personal portfolios. So our information presents for their guidance what the arguably best-informed professional investors, through their own self-protective hedging actions, believe is most likely to happen to the prices of specific issues in coming weeks and months. Evidences of how such prior forecasts have worked out are routinely provided. Our website, blockdesk.com has further information.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.