Daniel Banaszak

Daniel Banaszak
Contributor since: 2013
Hey cswli8, thanks for reading. 2011 was an interesting year for the VIX. It did spend the majority of the time in contango, but the time it spent in backwardation was continuous. In most instances, the times we see a spike in the VIX are usually followed by an immediate and swift reversal of that move. It's a prototypical "buy the dip" type of drop in equity markets that's quickly recovered as both implied and realized volatility drop almost as quickly as they rise. However 2011 was more like 2008 in that realized volatility was sustained for an extended period of time, which served as a support for implied volatility to stay elevated, despite equity prices not dropping nearly as far in 2011 as they did in 2008. The term structure remained in a state of continuous backwardation as a result, just waiting for the big drop in the VIX, which eventually happened in October and into November of that year. And when backwardation is sustained, it adds up quickly since, in terms of VIX points, the term structure is more severely upward sloping in backwardation than it is downward sloping in contango.
Thanks kmi. I appreciate your comment.
You make a great point Barath. I think that's a part of the fundamental risk/reward relationship on these ETP's. It is an interesting phenomenon. The market is okay with paying you to hold the long VIX ETPs like VXX or TVIX, but the tradeoff for that is the VIX's strong tendency for mean reversion when it is at elevated levels. The roll yield can be in VXX's favor during backwardation, but there is always the risk you just mentioned of a swift move back to lower vol levels. I think, that being the case, is why these products are really best for the pros and the guys who really can discern shifts in market implieds.
I would consider that a fair statement. Just remember though that over short time frames sharp, sudden up moves in the VIX can overwhelm profits from a short vol position. Managing your risk on those shorts is an absolute must, especially so for the levered products like UVXY.
VIX Central is a great site for that.
Thanks for reading Jon. I find that the term structure can be an excellent guide for those seeking hedges in high vol markets. Historically speaking, the term structure has gone into backwardation immediately before you see significant increases in the general level of volatility. What's even more interesting is that it has reverted into contango with volatility still at high levels, presaging a return to a lower volatility regime. I'm not suggesting this is a silver bullet because the future does not necessarily have to repeat the past.
I am actually working on another piece that shows the distribution of the term structure historically. I found over the whole data set I looked at, contango predominated over 70% of the time. However, this set was "lumpy" with different levels of contango/backwardation dominating over certain time frames.
It's a great question Pairs. I actually read a very interesting article the other day at Condor Options by Jared Woodward. That's an outstanding site. He did a piece on the correlation of the returns on VXX and SPY as a gauge for when to exit short vol positions. The link is below, you should check it out.
Hey Dan, thanks for reading. You are absolutely right about 2012. That was definitely an extreme year for contango in the VIX futures market, I may have been cherry picking on that, if only to prove my point.
That's an interesting way to estimate a cost of carry on the futures. That should definitely get you in the ballpark on an annualized cost.
Thanks ikkyu. This is my first SA article, I appreciate you taking the time to read it.
Hey Harry, thanks for reading. If you want to pursue a short volatility strategy for the extended term, XIV or SVXY is probably the easiest position to put on. Using options on VXX or even a direct short on VXX represent a more sophisticated approach that require more time to stay on top and are more difficult to implement, but give you more flexibility in handling the short position.
Just remember whatever avenue you seek, that any short volatility position carries substantial risk and should only be pursued by those with extremely high risk tolerance. XIV returned in excess of 150% in 2012, but also went through a drawdown of nearly 75% the year before. Risk management is an absolute must on a short volatility position to keep the trade viable for the long term.
Thanks for reading Rseye. I guess we shall see. Cyprus seems to be having an outsized impact on markets right now given its small size in relation to the whole Euro-zone. The VIX has come off the lows from two weeks ago slightly and if the markets start rocking you should see some good decent upside in the VIX ETPs. But I really don't see any equity market downside as more than a minor correction at this point. This could be a decent entry point to dipping your toes in some long vol positions, but at this point stops should be tight and any winners should be exited with extreme prejudice I think.
MT, thanks for reading. You are correct, the market does move bigger in both directions during high volatility periods, this is the very definitino of volatility. But, as it relates to the pricing of the VIX and VIX futures, you also need to consider the direction of the move, not just the magnitude. Honestly, that is well beyond the scope of the article and I'm not sure what your experience in trading options is, but this is a phenomenon known as the volatility skew. Simplistically, an equal move up and down in equity markets will lead to either a higher or lower VIX value, despite both moves being of the same magnitude.
In fact, the volatility skew is a major component for why there is a statistically signifcant negative correlation between the VIX and equity markets as measured by the S&P 500. As such, VIX futures do represent a potentially viable hedge for an equity portfolio. But, as I show in the article, this is a very expensive hedge not worth holding forever.
And I do apologize for not being clearer on the charts, honestly I'm brand new to writing these posts. I appreciate the input and will try to explain the charts clearer next time I write. UX1 is the generic futures symbol in Bloomberg for VIX futures. So a comparison between VIX and UX1 is looking at a performance comparison between the VIX itself and a strategy of buying a VIX future, holding it to expiration, and rolling into the next month's VIX futures contract.
Thanks for reading MT. I'm trying to get a reply and seem to be having issues with a longer response.
OMG. You are correct in observing that these products can provide some outsized returns in a very short period of time, I wholly agree with you here. I can't argue with a 6% gain in less than a day. In fact, in my opinion that is where these products operate best in, as day-trading vehicles (like in your example) or as short-term swing trading vehicles.
You can think of the returns on these vehicles as consisting of two components: one component for the movement in the VIX futures and a second component which represents a cost of carrying the VIX futures which these ETPs hold. In any single day, the movement in the futures will easily overwhelm the cost of carry. This is why, as you succinctly note, it is possible to make large profits in short order with these ETPs because the futures they hold are very volatile in their price swings.
However, even though it's not easy to see the cost of carry component embedded in a VIX futures contract, you must understand that it is there, it adds up every day, and it is quite large over time (an average month for carrying costs can range from 6-10% depending on the steepness of the VIX futures curve).
I'm not saying you can't make money on these things if you hold it for more than a few days, because if you hit the nail on the head on a market correction, you can really rake it in with these ETPs. But remember, you really need to be pretty exact on the market timing component for that to happen due to the cost of carry issue
@Eric Exactly. AAPL's core competency is creating new markets where none previously existed. However, since the unfortunate passing of Steve Jobs, I have yet to see or hear of a new breakthough in AAPL innovation. The iPhone 5 and the iPad Mini are souring examples of what the trend in AAPL's stock price is saying. Namely, AAPL lost their core competency when Steve Jobs passed. True innovators are hard to come by, and in technology, innovation is everything. AAPL needs NEW products, not refinements of current products. Without new products, Samsung will eat AAPL alive because Samsung's core competency is making an existing product better. AAPL is a fish out of water with the iPad Mini and iPhone 5.
Hey I agree blueline. I just don't expect any compromise from Obama for the next 4 years at all. I don't consider a 50-48 tally in the popular vote to be a mandate, but that doesn't mean Obama doesn't think that he has been given one regardless.
"Perhaps he'll be mindful of his legacy and go above and beyond the call of duty and reach out to the Republican-controlled House and bridge the bitter divide that's brought the country to this perilous point of fiscal vulnerability."
When the man's campaign slogan is "Forward", I don't think it's a legacy of compromise and bipartisanship that he is interested in leaving. I think the message is clear, get on board or get out of the way.
You are missing the futures market. It's really a 3-way arbitrage between the stock components of the index, the index ETF, and the index futures. Overnight futures trading will determine where the index and the arbitraged index components will begin in their opening range the next day.
Interesting. Liquidity risk would explain those large negative returns in 2008. Thanks for the info and sharing more insight on the matter.
I appreciate the long-term sentiments. But a question you will want to ask yourself as a long-term investor in REITs is if you can stomach the substantial tail risk inherent in owning REITs. Drawdowns in excess of 70% hit REITs across the board in 2008. If you can be genuinely honest in saying that you have no problem sticking to an investment that you are down on by more than 70% at any potential point in the future, then by all means buy and hold forever.
Maybe SDS is a better mousetrap for leveraged inverse ETFs. But it's a better version of a product concept that is doomed to fail. Look at the cumulative returns back to the 2006 inception of SDS and it's Proshares counterpart 2x long SSO. SDS is down 82%. Not unexpected given the last 3 years of bull market. But what's incredible is that SSO is also down...10% over the period.
You could have simply shorted both the 2x long and 2x short S&P products back in 2006 and you'd be up at least 50% on your trade today. Leveraged ETF's make excellent day-trade and intermediate swing trade vehicles, but at time horizons longer than that, just short all of them and you will be happy you did.
Just imagine the size of the mess that Obama will inherit from Bush if he gets re-elected.
-13.2%...wow. Now THAT is bullish. Here comes QE-infinity-squared.
Applying fundamentals to price action. How quaint.
Except for the drawdown you get hit with in a Black Swan event. All modern investment theory says Black Swans are impossible to occur, that years like 2008 won't happen but once in 1,000 years. The stock market has been hit with Black Swan-type drawdowns twice just since 2000. Now relative to break even as a long-term investor, you are highly likely to make yourself at least whole. But relative to the opportunity cost of having a portfolio that does not experience large drawdowns like 2001-2002 and again in 2008, you will be far, far behind that portfolio over long periods of time. It's somewhat illusory to say that long-term investing immunizes you from the negative effects of Black Swan events, when in fact, long-term investing only guarantees you will suffer deleterious drawdowns that cost you money you don't even realize you could have actually not lost.
Wow, that's a laughable notion. The Fed thinking about removing stimulus? Good luck with that. The stimulus went in to stave off a depression. Guess what will happen if the stimulus goes out? Depression.
The fix is here for good. Our markets and economy must continue with this status quo of zero-bound interest rates, a massive monetary base that doesn't turn over, and 0-2% real GDP growth. The only other outcomes are depression (if we attempt to remove the stimulus) or hyperinflation (we don't remove the stimulus and the monetary base trickles into the real economy as velocity accelerates).
This goldilocks scenario of having the economy gradually accelerate and having the Fed perfectly time the removal of trillions of dollars in liquidity from the financial system without either hyperinflation setting in or collapsing markets and sending the economy into a massive tailspin is far fetched in my view.
I'm pretty sure Japan is a perfect example of how unlimited QE does not create hyperinflation. You really should consider the case of the country that invented QE and has been putting into practice for the last 20+ years. The negatives of QE are not inflationary.It simply perpetuates the problems of capital being allocated to entirely unproductive uses, i.e., propping up failing banks and sustaining government deficits to prevent the deflationary effects of bursting massive asset bubbles in the private economy.
Well in Japan it's more honorable to kill yourself than break your promises, or in this case, default on your debt.
Can we get another article arguing why QE23 won't happen in Japan?
It's funny. With public debt at 220% of GDP, nobody touches Japan in the indebtedness department. Pick up a news feed from Japan and look for all the headlines about solutions for their government debt problems.
QE4? Are we not figuring this pattern out yet? I laugh at everybody who says QE3 is not coming. Even if it doesn't come this week, it's coming soon. Japan is on QE22 now I believe. It's funny because I don't hear one person talking about how great all these QE's have been for Japan. When QE3 happens, QE4 is the inevitable next step down the rabbit hole for us.
Well the theory goes that taking the Dow from 12,000 up to 20,000 will in and of itself create economic growth.