Monday, April 18, 2011

Monday Morning Outlook: Putting a 'Cheap' VIX in Historical Context (VIX; VXX; TVIX)

I'm not sure I'm in agreement with this analysis. There is a long-shot argument to be made for a VIX run to 100, we'll have more later today. The 15.32 close on Friday was the lowest volatility reading since 2007.
From Schaeffer's Research:
Stocks continued to inch away from key technical resistance levels last week, but options-related support helped keep downside to a minimum. Now, the beginning of a five-week expiration cycle raises the prospect of additional short-term headwinds, as a two-month low in the VIX could entice anxious investors to scoop up portfolio protection. However, Todd Salamone argues that bulls still have the edge in this endlessly churning market -- and, as a matter of fact, the VIX might not be so "low," after all....

...With April expiration now behind us, the CBOE Market Volatility Index (VIX - 15.32) enters the week trading in the 15 area again, which has been a floor since December. Evidently, those seeking protection against a downturn view portfolio insurance as "cheap" when the VIX ventures down into its present area. And with many protective puts expiring this past week, it wouldn't be a major surprise to see index put buyers active in the days ahead. Such activity can be a headwind for equities, as sellers of portfolio insurance hedge by shorting futures.

But the VIX is not as "low" as it appears on the surface. For example, in late December and early February, the SPX's 20-day historical volatility was registering readings of 11.0 and 11.3 when the VIX was trading in the 15-16 area. Right now, SPX 20-day historical volatility is just over 8.4, which would suggest the VIX is relatively high, even as it trades at chart support and may be considered relatively low by most portfolio managers. The bottom line is: Based on SPX historical volatility, the VIX has room to move lower.

 Daily Chart of VIX since November 2010

On a related note, since April expiration came unusually early, the upcoming week marks the first of a five-week expiration cycle. Our research indicates that during the past five years, the first week of a five-week expiration cycle has had a negative bias.

SPX weekly returns since 2006

Our theory as to why this particular week has a negative bias is related to those looking to add portfolio insurance via the purchase of options on indexes and exchange-traded funds. The put options that are purchased at the start of a five-week cycle are more sensitive to changes in the underlying than options that expire in four weeks. Therefore, sellers of the portfolio protection that typically hedge will sell more SPX futures in the first week of a five-week expiration cycle relative to the first week of a four-week expiration cycle....
 See also:
"Must Read: Is Volatility Broken? Normalcy Bias And Abnormal Variance" (VIX; VXX; TVIX)
The Bernanke 1×2 Call Spread (TVIX; VIX; VXX)
What Does the VIX's Lightning-Quick Fear/Complacency Cycle Mean for the Market? (VXX)