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Market Volatility Bulletin: VIX Losing The 'Trade War'

by: The Balance of Trade
The Balance of Trade
Derivatives Strategy, trading, portfolio strategy, Educational Focus

Earnings season is shifting traders' collective focus, and the S&P takes another stab at breaching 2800.

Do central banks coordinate their actions?  If so, I see the sense in having the ECB continue to ease while the Fed tries out tightening.

The M1-M2 debit spread looks attractive based on current dynamics in the term structure relative to S&P, HV, and spot.

Market Intro

CNBC: 9:58 AM

Monday saw real follow-through in US stock markets (SPY, DIA, QQQ, IWM); the Dow in particular performed strongly. Tuesday has thus far been about mild consolidation of those gains in international markets (ACWX, EFA, EEM, EWG). Spot VIX now manages a twelve handle, with the S&P trading at the top of its six-month range, other than the peaking that occurred in late January right before the plunge.

Sector SPDR: Monday performance

Financials (XLF) had a strong day on the back of earnings, but readers should note that utilities (XLU) drew back quite a bit, and this in spite of the fact that interest rates (TLT, BND) really did not buck much higher.

CNBC: Tuesday 9:25 EST

I expect that volatility on the pound-dollar (FXB) (or really pound-anything) trade "May" pick up here as the Brexit negotiations have hit a rough patch with the resignations of David Davis and Boris Johnson.

Thoughts on Volatility

One of my favorite sayings comes from David Darst: Markets don't change when fundamentals change; markets change when beliefs change. Remember Italy (EWI) just a few weeks ago? That had us tradin' at S&P 2675 for a bit… until traders just decided not to care. The key is that in secondary markets, sentiment counts for the majority of price action. That is one reason understanding volatility metrics can be helpful to grasping the overall state of the markets, regardless of whether one trades some particular volatility strategy or other.

While each central bank is unique, I do believe that they coordinate their actions to the extent that they are able to. Likely this happens more through back channels than out in the open, as the publicity tone of central banks "colluding" has a different feel than, say, nations striking a new trade agreement with one another. I think that it is actually wise to have the Fed tighten while the ECB taps the gas, if we consider the net aggregate impact and experimentation with the impact of a reduction in the Fed's monetary base.

I do bring up the vol ETPs here, but I do not as often mention the mid-term short (ZIV) or long (VXZ) products. Mostly they do not have as much activity or movement. But I will say that these ETPs can provide a more stable, if less exciting, set of exposures that ultimately reduce one's chances of large melt-downs, as we have seen both on the long and short side over the past twelve months in the shorter-dated products.

Term Structure

If you want to call anything extreme, it would have to be the VX9D… saddled almost equidistant between spot VX and 10D HV (which are now equal) and 20D HV. This suggests to me that the M1 is in quite a precarious position… a pretty important catalyst is necessary to keep the term structure from bowing in further. Long the M1-M2 spread looks appetizing here.

Going back three months, the VX futures have put on quite a show. SPX is up approximately 6% in terms of price over that time frame. I want to emphasize that while futures today are exactly where they were in mid-June, neither HV nor the term structure are nearly as extreme. Market divergence between the US and emerging markets (EEM) may suggest that the Trump administration is from a purely market perspective "winning the trade war", though I do not want to get into the weeds into all the implications of such a statement.

Earnings are coming in strong so far this quarter. I do think we may struggle a bit once more at this level, as we did the last time around three weeks ago. But I do believe that the impetus is now there to take a real stab above 2800. This really is a decent environment for short vol (SVXY), as it is difficult to call the current move in the purest sense "overextended" (as it most definitely was back in mid-June).


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.

In yesterday's MVB, RyGuy got a good conversation teed off regarding strange pricing in the UVXY options. Topics flowed between skewness vs. the impact of a dynamic term structure on a product that is itself the construct of a moving blend between two futures curves that exhibit somewhat independent behavior from one another. My deep appreciation to all who participated.

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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.

Additional disclosure: 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.