One of my favorite sports related poems is "Casey at the Bat," by Ernest Thayer. I would like to quote it in its entirety but I will just go for the last stanza and a link to the whole thing.
Oh, somewhere in this favored land the sun is shining bright;
The band is playing somewhere, and somewhere hearts are light,
And somewhere men are laughing, and somewhere children shout;
But there is no joy in Mudville - mighty Casey has struck out.
Anyone that was long volatility yesterday was hoping that this poem would apply to Ben Bernanke's announcement at the FOMC meeting. After Draghi and the German Supreme court ruling going through without a problem, a disappointment at the Fed meeting was the last chance for the market to experience significant volatility in the near term.
Well, after yesterday's announcement it appears that Mudville is likely rioting in the streets with jubilation from the printing bonanza the Fed is committing to undertake. Let's take a look at the steps that are being taken to try and understand just how committed the Fed is to stock market inflation:
- $40B monthly purchases of Mortgage Backed Securities without an end date
- ZIRP extended from 2014 to 2015
- Extension of the Twist
- Commitment to ignore inflation until employment improves
$480B annually in new QE, extension of the current efforts and the willingness to let inflation run hot is much more than I expected Bernanke to deliver and the market appears to agree with me. If we had just seen a limited QE or just a few of the steps rolled out, we might have seen a "sell the news" event. Instead we got a monster rally and will likely see more follow through today.
While I think that this decision is extremely short sighted and will just foster a bubble in commodities and equities while fostering demand destruction, that doesn't matter for anyone trading short term volatility.
And You Thought It Was Flat Before
Bernanke's efforts yesterday has crushed volatility anew.
- Spot VIX: 14.05
- September Future: 14.90
- October Future: 16.45
- November Future: 17.95
The Spot/Front month future has increased the gap even as spot VIX fell apart yesterday. Moving from 1% to 6% we are back to a steeper curve that is only worsened by the front/next month gap sticking around 10%. At this point in the duration of the September contract all of the volatility products consist mainly of October contracts, therefore the gap between spot and front month is less important as even if the September contract continues down to spot, it won't have much impact on VXX, UVXY and TVIX as long as the October contract stays where it is.
I include the November future because it will become relevant next week when the September VIX contract expires and the volatility products start rolling into the new monthly contract. Once we get to Wednesday of next week, the market makers that run volatility products will be selling October contracts and buying the November contract. With over 16% between October and spot and 9% between October and November, the upcoming term structure is looking steep even though we are entering goldilocks territory levels in spot VIX.
Hopefully everyone was able to get out on the relative strength that we saw over the last few trading sessions as anyone that is still trapped in their chosen long volatility product is likely in for quite a drubbing in the coming months.
If the upcoming term structure plays out without any significant spikes in volatility, we could see a 50% reduction in the leveraged volatility products (UVXY, TVIX) by the time the November contract expires. Will this definitely happen? Who knows, but with the central bankers of the world all working together to crank up the printing machines, being short assets and equities or long volatility are going to have to be short term scalps at best because the upward bias is going to be very hard to resist.
With the efforts outlined by the Fed and the ECB now seemingly operating with the blessing of Germany, we could see months of a low volatility climb up the wall of worry. The bankers are initiating their next asset bubble with printed money and it will be futile to try and resist it, at least in the short run.
Luckily, in the U.S. at least, we have a deadlocked Congress that is so committed to accomplishing nothing that the upcoming Fiscal Cliff and Debt Ceiling breach should provide an entry point for those interested in positioning themselves long volatility. The Debt Ceiling should be breached in January and the Fiscal Cliff will have impact in December, so as always, there will be more chances to profit from increased volatility.
Until then, though please reconsider your position if you are currently long volatility. With the market now back into euphoria, ignore all news mode, we could see spot VIX head all the way to new lows, maybe even down to 10-11. The term structure will remain fairly steep due to unbelievers but until we get into November and past the elections, I would favor buying dips in XIV or SVXY over trying to time scalps in UVXY and other long volatility products.