Fall Volatility Ahead? The Futures, Options, And ETPs Are Already Expensive

As usual, the "sell in May" punditry is back. But this time of year, they spout that September is historically terrible for the markets, nothing is solved in the Eurozone, the U.S. economy is teetering on recession, and you should be trimming back long positions. (insert yawn here)

The truth is that all of these statements are not only very debatable, some of them are patently untrue. Sadly, Americans take headlines and CNBC at face value, and hate to do any homework. I would say they are ignorant, but Americans have such great qualities in learning new disciplines and engendering pure inventiveness (this link is a classic example of American ingenuity in the simplest form making someone a millionaire), that I strive to explain this particular facet of financial illiteracy. I suppose it's just too damn boring for most people to care while they're inventing the new social IPO.

If you believe the nitwits on CNBC, and were considering buying calls on the VXX (please folks, the VXX itself is just something to play against, never to own), a word of caution is warranted. The VXX now holds virtually all September futures, and they are currently running at $19.30 while the spot VIX is $15.96. This is before a daily roll into the October contracts at $21.60. That is a 12% monthly hit divided by 20 days, for a daily .6% headwind. If you thought the VXX was a short term vehicle, the calls should be treated like a newborn needing a bottle every two hours.

Ok, so lets look at owning the stuff that they cram into these garbage ETFs. They have not packaged the VIX options into an ETP yet, but that would probably be better than owning the futures contracts, as these things are just flat out rip-offs:

VX U2-CF	S&P 500 VOLATILITY	September2012	16:40:24	19.30	0.29	19.00	19.65	18.80
VX V2-CF	S&P 500 VOLATILITY	October2012	16:40:25	21.60	0.32	21.15	21.75	21.05
VX X2-CF	S&P 500 VOLATILITY	November2012	16:40:24	23.20	0.41	22.80	23.25	22.78
VX Z2-CF	S&P 500 VOLATILITY	December2012	16:40:24	24.30	0.51	23.80	24.35	23.80
VX F3-CF	S&P 500 VOLATILITY	January2013	16:40:23	26.00	0.35	25.60	26.10	25.60
VX G3-CF	S&P 500 VOLATILITY	February2013	16:40:23	27.10	0.18	26.80	27.20	26.80
VX H3-CF	S&P 500 VOLATILITY	March2013	16:40:23	27.90	0.23	27.54	27.95	27.54
VX J3-CF	S&P 500 VOLATILITY	April2013	08:34:54	28.40	0.30	28.10	28.50	28.10

Click to enlarge

When is Mr. Buffett going to get into this game? He loves free derivative money as we all know.

So let's look at the Sep calls off the actual VIX:

16.00	VIX120919C00016000	3.70	0.30	3.60	3.80	3,848	12,100
17.00	VIX120919C00017000	3.10	0.20	2.95	3.10	872	9,248
18.00	VIX120919C00018000	2.55	0.15	2.50	2.55	644	19,776
19.00	VIX120919C00019000	2.15	0.16	2.05	2.15	4,851	63,991
20.00	VIX120919C00020000	1.75	0.03	1.70	1.80	7,037	77,495
21.00	VIX120919C00021000	1.55	0.10	1.45	1.55	7,881	50,420
22.00	VIX120919C00022000	1.35	0.10	1.25	1.35	1,137	62,709
23.00	VIX120919C00023000	1.10	0.05	1.05	1.15	18,013	90,332
24.00	VIX120919C00024000	1.00	0.05	0.90	1.00	6,094	78,095
25.00	VIX120919C00025000	0.88	0.03	0.80	0.90	5,797	118,358
26.00	VIX120919C00026000	0.82	0.07	0.70	0.80	3,077	42,369
27.00	VIX120919C00027000	0.70	0.05	0.60	0.70	1,602	37,788
28.00	VIX120919C00028000	0.65	0.05	0.55	0.65	22,376	130,955
29.00	VIX120919C00029000	0.55	0.05	0.50	0.60	1,315	74,800
30.00	VIX120919C00030000	0.50	0.00	0.45	0.55	6,807	121,793

Click to enlarge

Are you kidding me? Sep at the money's cost $3.70! What are we expecting this fall anyway? This is a classic example of recency bias. We've seen recent Sep's be terrible months, but how can the world fall apart when every minute of every day we read on the front page that bad things are about to happen? We get it, Greece sucks. Sell some islands....

The point here is simple. If you want to hedge, you're going to pay the piper. In the insurance industry, this is called a "hard market" because Buffett's parking lots are full with new appointments. Short story: the insurance industry, including the CBOE, is charging a lot of money to hedge, and while Mr. Hedger (name that dumb college endowment manager _____), wants to pay to sleep at night, you don't have to.

We've laid out the landscape, but what do we do now? My answer is pretty simple. Start some put buying in the VXX, VIXY, VXZ, whatever your particular flavor may be. As long as you are far enough out, and you average down (a sin I hear, but in this case you don't have CEO's liquidating on top of your stake) it's just pure math. If we get a monster crash, your risk is defined. If not, we will enjoy cocktails with the bonus babies at Goldman....

Disclosure: I am short BATS:VXX. 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.