ARE YOU READY FOR A 60% SURGE IN VOLATILITY?
Steven Sears had a good piece in Barrons over the weekend disussing the low level of the VIX. As the market has continued to melt higher we’ve seen increasing levels of complacency as investors become increasingly comfortable with the market and their belief that it simply cannot decline. While the economic fundamentals certainly back this outlook it’s always nice to have an insurance contract in your back pocket just in case. In this case, it might be a bit of covered call writing or some outright VIX purchases.
Sears notes that MKM analysts believe the VIX could jump 60%+ in the coming months. Not a bad insurance contract to have just in case. Better yet, it doesn’t keep you out of the game entirely. Remember, you can’t hit a pitch you don’t swing at. But now isn’t the time to be swinging for the fences. Via Barrons:
“ONE SELDOM-DISCUSSED REALITY of the modern options market is that the computers that control pricing models sometimes get out of tune with market reality. As stocks grind higher, as occurred in the fourth quarter, the models anticipate lower implied volatility because stock prices have advanced in the past. The past few days saw institutional investors buying bearish puts to protect against a decline, but the action wasn’t significant enough to cause a rapid increase in implied volatility.
A lesson of the past year is that wise investors buy volatility when it seems too low, and sell when it is too high. The volatility metronome also works for timing stock trades.
Risk premiums, as measured by the Chicago Board Options Exchange Volatility Index, are too low now, given the cross-currents roiling the surface of the stock market. This typically marks a good time to buy defensive index options to hedge against broad-market declines and volatility spikes.
With VIX around 18, Jim Strugger, MKM Partners’ derivatives strategist, is telling clients to buy VIX Feb. 21 calls and sell VIX Feb. 30 calls to protect against an earnings-season volatility spike that could temporarily interrupt the bull advance.
“After being bullish on equities since late August, and riding this volatility wave lower, we’re saying, ‘get ready for a VIX spike to 30,’ ” Strugger says.”
Source: Barrons
What’s the best hedge if you’re bullish, but worried about a 20% decline?
I’am in since monday 17 at 15.40. Risk asymmetry and bargain price according to market situation. Still no other defensive trade. Just selling in the strength.
May I remember the VIX follow almost the same pattern during the recovery after the techno-bear? Going in under the “16-17″ area in 2004, and stay stuck in there during almost 3 years? Market conditions look like in 2004 (while Commos and China look like 2008).
“Going in under the “16-17″ area in 2004, and stay stuck in there during almost 3 years? Market conditions look like in 2004 …”
The only reason the VIX stayed low after 2004 for three years is because of the inflated values caused by the housing bubble. Every chart you look at in house valuations shows anomalous increase during the years 2003 to early 2008. That lifted all valuations during the bubble, hence the name and took the VIX historically lower. Healthy areas have gone back to the 2003 curve on those charts, bad areas have sunk much below those levels.
We don’t have that this time, in fact we have decreased state, muni, fed revenues, and outstriped expenditures (spending). Asset valuations of houses have fallen and there is a constant problem with wage decreases and that pesky unemployment.
The VIX will go this year and when it does it will be big.
Successful investors ignore the noise and the volatility and they keep investing through thick and thin through the ups and downs of the market.
Maintain a historical perspective on the daily price of VIX. The ‘average’ VIX for the past 20 years is 20.2, so the current 18.47 is just slightly below average, not “low”, on an absolute basis. Given that overall risk is now only very slightly elevated, http://research.stlouisfed.org/fred2/series/STLFSI/
a substantial rise in VIX (say 60% as the Barrons article references) will likely only occur if there is a relatively quick (say over the next 1 or 2 months) substantial sell-off (say 5-7%) in the overall stock market.
On Friday VIX closed above 18 for the first time since December 6.
There is a lot of smart money that is preparing for volatility. Marc Faber thinks 2011 will be volatile and Felix Zulauf rec’d buying VIX futures in Barron’s yesterday.
I bought vxx at 32,50. I am prepared for volatility:). I know VXX is horrible, but it is just for trade…
please elaborate on your thoughts on why VXX is horrible.
I sold ATM VXX puts a week + back
VXX is a blessing……. to be bearish on.