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Saturday, May 5, 2012

VIX Rising to 24.6 Before May VIX Settlement?

 
Something interesting happened at close of Friday to VIX.  As you can see from left chart, the green line turned positive (which does not happen often).  The green line is the Point&Figure Trend Indicator found in Metastock Technical Analysis software.  I will not go into explanation of this indicator, but it is a good indicator to use for instruments that exhibit strong moves in direction and scope, such as VIX.
 
I did some further analysis and found that since 2000, P&F Trend Indicator turned positive a total of 18 times not including the most recent turn, when VIX was less than 25.

The table shows the max % gain and max % loss of VIX after the P&F Trend Indicator turns positive.  I chose 8 days as a forward looking period because there are 8 trading days (7 + overnight) to go before May VIX settlement.  As you can see, the max % gain of VIX within 8 forward trading days averaged 28.6% and the max % loss averaged -6.7%.  That would mean that the expected range of VIX in the next 8 trading days is 17.9 - 24.6.  VIX closed on Friday at 19.16.  Admittedly, it is hard to determine "expected values" with such a small sample of data.

I did notice two instances where right after P&F Trend Indicator turned positive, VIX immediately plunged (highlighted in yellow in the table).  First was on 3/22/2004 and second on 3/13/2007.  (see third chart, dates in blue circles) I do not believe the market environment on 3/13/2007 is similar to the current market environment.  In particular, VIX had already risen 80% from recent low then of 10.02.  March 22, 2004, however, could represent a similar market environment to that of the current one.  There were concerns then about steep valuations and the market having come up too high too fast.  Here are 2 links after a quick google search that can provide some market color on March 22, 2004. 1)http://www.hussmanfunds.com/wmc/wmc040322.htm and 2)http://finance.groups.yahoo.com/group/investorguide/message/223.  One thing is common with both dates however.  The P&F Trend Indicator reversed to negative just 2-3 trading days after it turned positive--meaning that if the latest signal results in a whipsaw trade, one would likely not have to hold the position for the entire 8 days and incur maximum losses.

Unfortunately, VIX is not an easily tradeable instrument.  One could buy May VIX Futures.  It closed on Friday at 20, which is 4.38% premium over VIX.  While the average premium with 8 days to go before expiration has been 1.96%, if we put in a filter with VIX <25, the average premium of VIX futures over VIX has been 4.73%.  One could buy the VIX May 19 calls at 1.95...Or perhaps a superior risk adjusted strategy may be to buy the VIX futures spread (buy May, sell June or July) or buy VXX and sell VXZ as a pairs trade.  Should VIX jump, the front month VIX futures should rise considerably more than the back month VIX futures.  Of course, if we get negative market impacting news from Europe over the weekend, the opportunity to make a trade on this analysis may have slipped away...

Finally, VIX has been moving incredibly close to my FVE model for the past several weeks.  Looking forward to Monday, my Fair Value Estimates for VIX are indicating ~19.5 (SPY rising 2%), ~19.3 (SPY rising 1%), 19.5 (SPY unchanged), 19.7 (SPY falling to 136), and 20.1 (SPY falling to 135).  On Friday, VIX closed at 19.16 while FVE closed at 18.9.

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