Market Volatility Bulletin: Clawing Out Of Purgatory
- Stocks are spending the morning (and most of the pre-market) trying to shake it off. VIX looks extremely neutral as to whether this is doable.
- Implementing trade or investment decisions can be very scary when the environment shifts so rapidly and radically. Take a walk and try to come up with reasonable responses.
- Skew is quite low: a rally is far from certain, but at least looks like it's in the cards.
CNBC: 10:25 AM EST
US stocks (SPY, DIA, QQQ, IWM) are trying to hold on after Monday's vicious attack from the bears. Amazon (supposedly) led the fall, but as you'll see below, the devastation for stocks was very widespread; it's difficult to lay blame at any one company's feet.
Asian stocks (EEM, EWJ, FXI, EWY) held on well all things considered. In general, globally speaking stocks are the only asset class that is truly tied up and spun around at present:
Precious metals (GLD, SLV) are retreating as risk-assets try to get their act together (more on this in Thoughts on Volatility). Gold volatility is trading very mid range relative to the last year. For those looking either for a break-down in gold, or the geopolitical situation to further deteriorate, a long position in gold volatility could be a solid play.
Thoughts on Volatility
In keeping with the "Gold VIX" graphic from the intro, TopDown Charts shares insightful perspectives as it relates to the price of gold vs. real yields (inverted right axis for yields). A popular belief holds that as real yields rise, the opportunity cost of owning the metal also rises, which should adversely impact the price.
TopDown Charts shares the following:
To be fair, not all people think about gold in this way. In fact, many people think of gold as a risk hedge (e.g., as I am writing stocks were down -3% today vs. gold up +1.5%), and indeed, probably a big explanation as to why gold has diverged from real yields is hedging demand as investors worry about a potential bear market and heightened geopolitical risks. But even if that is your thinking, the idea of opportunity cost is still relevant, and indeed you might even think of it as simply the cost of hedging (remembering that there is no free lunch in markets!).
This two-sided approach balances out well in my opinion how different participants can consider the pros and cons of a given asset. In any event, gold volatility is well within the middle of its one-year range. If there is a big move coming, gold VIX doesn't see it.
There's an old Yiddish saying: "You want to make G-d laugh? Tell Him your plans." It is easy to say that one will buy and the next downswing. But when the levy breaks, taking action can be trying:
Monday's market action
Changing one's plans can be the sensible thing to do. Let's face it: the market had a larger high-to-low drawdown yesterday than it did for all of 2017! One could be forgiven for losing sight of risk last year. In fact, that was truly the most profitable strategy.
In the end, traders and investors should go on more walks, really think about what it is that they are trying to accomplish, and make a methodical plan that is hopefully robust. Write it down!
I think 2018 is an excellent year for making structural adjustments to how you trade or invest - there are a lot of cross-currents out there and so far it looks like a year where a variety of disciplines (macro, EPS, valuation, technicals, vol) all want to throw their hat into the mix. A healthy dose of humility, a hobby that has nothing to do with following markets, and a sense of humor will likely serve us all well.
There is plenty of time on the April contract, but it happens to be hugging spot VIX rather closely at the moment. I wouldn't read too much into it. Spot itself is just biding its time, trying to assess an appropriate volatility risk premium, while at the same time remembering that at these levels the risks remain quite two-sided.
Recall that if we just hang out here, it is likely that skew will push higher, perhaps alongside VVIX, but spot itself would probably be inclined to fall alongside realized vol. Keep an eye on the spread between 10 and 30-day realized vol. Overall I'd say a convergence is a good thing for the short-vol camp (SVXY).
Skew, or the implied vols for OTM puts vs. calls, is at the month's low after trading basically at an all-time high earlier this month. Now high Skew levels certainly can be false indicators; in this instance that was most certainly not the case.
This may serve as a reminder that the options market is giving a pretty decent prospect to upside still being on the table for the SPX. Put a little differently, Skew is telling us that a sea of deep green analogous to Adam Warner's chart above should be weighed in as a meaningful scenario.
In the meantime, VX futures do remain in backwardation (albeit modest), with roll yield favoring long-vol positions (VXX, UVXY, TVIX). If the yield curve holds in favor of these positions, there is no intrinsically good reason to abandon them for traders who know how to manage them (also, VXX has a pretty solid options market as the ETPs go).
If this is your first time reading Market Volatility Bulletin, thanks for giving it a try. If you're a regular, we thank you for your ongoing contributions in the comments section.
Earlier in this MVB we spoke of multiple disciplines adding their two cents as to how to respond to the vicissitudes in the stock market at present. The comment from Tom Short from yesterday's MVB keys in on this concept below.
Perfect timing (he'll tell you as always), Jeff Gundlach, who manages billions in assets, speaks to the truth that "big money" does take technical into consideration when making buy or sell decisions. Just for clarity, Mr. Gundlach is a famous bond fund manager.
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I actively trade the futures and options markets, potentially taking multiple positions on any given day, both long and short. I also hold a more traditional portfolio of stocks and bonds that I do not "trade". I do believe the S&P 500 is priced for poor forward-looking returns over a long timeframe, and so my trading activity centers around a negative delta for hedging purposes.
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