VXX & ZIV Bias Indicators - October 2014 Performance Update

Th U.S. Stock market experienced a wild October, with the S&P 500 falling 9.8% from its peak on September 19 to a low on October 15, followed by a two week rally back to all-time highs. This extreme move was matched with a +170% gain in VIX as it rose to a three-year high of 31.06. Highlighting the swiftness of this move, VIX gained more than 10% on three consecutive days for the second time ever. Then, just as swiftly, it retreated with an unprecedented decline of -10% on three consecutive days.

Our Daily Bias indicators read these moves well and produced two great trades. A change to a positive VXX Bias signaled a buy in VXX on September 18 and a change to a negative VXX Bias on October 21 signaled a VXX sell for a gain of 21%. The move to a negative VXX Bias on 10/21 signaled time to move back to short volatility by buying XIV, a trade that is +7% as of October 31. Both of these trades helped us continue our quest to once again outperform the market this year.

Looking at year-to-date performance of the two VXX Bias strategies through October 31:
- Negative VXX Bias strategy: +21% vs +2% for XIV
- Positive VXX Bias strategy:  -5% vs -28% for VXX

Extending the performance time frame of the Negative VXX Bias strategy back to 2012:
- Negative VXX Bias strategy: +566% vs +411% for XIV

Turning attention to ZIV, the Positive ZIV Bias strategy was +1.3% in October bringing the YTD total to +4.8%.

Over the longer time frame back through 2011:
 - Positive ZIV Bias strategy: +391% vs 256% for ZIV.

Performance Data files: 
- VXX Bias: 2006, 2007, 2008, 2009, 2010, 2011, 2012, 2013, 2014
                - 2012-2014 (multi-year)

- ZIV Bias: 2011-2014 (multi-year)


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Hypothetical and Simulated Performance Disclaimer
The results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under- or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown. Additional performance differences in backtests arise from the methodology of using the 4:00pm ET closing values for XIV, VXX, and ZIV as an approximated trade prices for indicators that require VIX and VIX futures to settle at 4:15pm ET.

Watching For The Return Of Volatility

Hello and welcome back! I hope everyone had a great Thanksgiving break.

Today I wanted to provide a brief look back on volatility over the past several weeks and provide my thoughts on what it means going forward. Ever since the debt ceiling deadlock concluded in October, VIX has remained in a fairly tight range between 12 and 14. Meanwhile, the S&P 500 has notched eight straight weeks of gains.

In this post I'll be covering:

• Technical Review
• Forecast Review
• Nov 15 VIX Reversal
• Elevated SKEW
• Trading Plan (Member Access Only)

Technical Review
Taking a look at the chart of implied volatility vs actual volatility (from the VIX Futures Data page), we can see that the current VIX range is roughly the same as what we saw in the July/August timeframe (orange highlight), which at the time, bounced along the floor set by HV60 (actual volatility over the last 60 trading days). Actual volatility in the S&P 500 has continued to decline since then and the HV60 floor is now two points lower, hitting 10.28 on Friday. This premium in VIX to HV60 tells us that options sellers are not yet convinced that the low volatility environment we are currently experiencing will continue into 2014.

The VIX futures term structure shows us a pretty consistent contango since mid October, with nearer months cheaper than the more distant months. Overall the movement has been mostly sideways with a slight decline across all months, while the front months futures have fallen more rapidly toward spot VIX.

Forecast Review
Looking at our forecast charts we can see that the Bias (left axis) has remained mostly negative for VXX and positive for ZIV. During this past 6 months VXX has declined from $80 to $45 (-43%), while VXX inverses (XIV and SVXY) have each gained 45%. Meanwhile, ZIV has increased 18%, moving from $30 to $35.80.

Taking a look at the VXX Spike Risk forecast we can really get a feel for how sleepy the volatility market has been lately with only a couple days above the 30% risk mark over the past 6 weeks.

Nov 15 VIX Reversal
On Nov 20th I posted in our Members' Forum about a possible reversal in the VIX daily chart that occurred on Nov 15th. While it is still possible to break lower, this remains something for VIX traders to watch in the coming weeks, especially as we press up against the 200 day moving average at 14.37 (red dashed line).

Elevated SKEW
The CBOE SKEW index has been elevated near 130 for a few weeks now (weekly chart below) and is at its highest levels since March 2012. This value tells us that the options market views a higher probability of returns that are two or more standard deviations below the mean over the next 30 days, which represents a 15%+ decline in the S&P 500. Given the recent run-up in stocks an expectation of a pullback isn't too surprising, but is something to be prepared for nonetheless.

Trading Plan (Member Access Only)
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Volatility Trading Outlook With The S&P 500 At All Time Highs

With the debt ceiling drama behind us the S&P has responded by making new all-time highs, while the VIX has fallen back to levels from Sept 20 and are VIX futures are back in a moderate contango. From the VIX Futures Data page:

Since Oct 18, VIX and VIX futures have been essentially frozen with intraday ranges of only a couple points for VIX and a range of closing values of just 0.38 points. The fact that VIX futures across all months are not declining, but flat (and ever so slightly up in months 3-7), is indication that all may not be well -- especially as the S&P is hitting all time highs. Usually when we see the VIX term structure hold steady like this investors are starting to pick up on some sort of risk on the horizon (see May 10th - 21st), however, no risk seems to be readily apparent at the moment (although I can name several that are on my mind). Maybe this is just a period of consolidation after a swift move down, but it doesn't quite sit right with me.

It is a five week roll period this month, with 17 trading days still left until November futures expire on Nov 20. Assuming we manage to avoid unforeseen drama during this time we should expect Nov futures to converge towards VIX (Nov currently at a 11% premium to VIX), and VIX to fall along with HV20 towards HV60. This will cause VXX to drift lower and SVXY higher, however the entire futures curve is once again rather compressed with limited room to the downside and larger risk to the upside. I see a ceiling for XIV over the next few weeks in the $32-33 area (~$125 for SVXY). For ZIV, $36 looks to be the limit.

With people increasingly predicting new highs and getting greedy I start to get concerned and like to raise cash. No one really knows if we'll go on like this for months or if the rally ends tomorrow, but all good things come to end so it's always good to take profits along the way and raise stops to help manage risk.

Looking Ahead At VIX & VIX Futures Near All-Time Market Highs

The stock market has been rallying in full force over the past month with the S&P 500 up 7.2% since it put in its low on 6/24.

VIX has fallen 34.5% since that date with VIX futures following suit across the board (see chart below), driving VIX-related ETPs accordingly:

XIV:  +40.7%

ZIV:  +16.6%

VXX: -30.0%

UVXY: -52%

Our Daily Forecasts have performed well over this time, with the VXX bias shifting from positive back to negative on the evening of 6/21...

...and the VXX Spike risk dropping back below the danger zone (60%) on the evening of 6/25 and staying there ever since.

Actual historical volatility of the S&P 500 has started coming into play to hold the VIX up a bit. HV60, the actual volatility over the past 3 months (60 trading days), is serving as a floor to the VIX, as can be seen in the chart below.

For trading of VIX ETPs over the coming weeks what's important to note is...

Continue reading this post on the Members' Forum

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VIX and SPY Show Positive Correlation For 4th Day In A Row

VIX Futures down slightly today, but remain largely unchanged at the close for 4 days now. The S&P pushed up to within a point of new all-time highs during the day but VIX futures diverged as can be observed in the intraday SPY arbitrage model.

With the VIX futures term structure mostly stationary the spread for the front two months remained at -0.85 making for a roll yield that isn't benefiting XIV much (this lack of movement has also resulted in a mostly stationary VXX Daily Forecast).

Spot VIX also diverged from its normal inverse correlation to the SPY again, making it 4 days in a row or positive correlation. I'd love to see someone run through the data on this to see when the last time was that this happened (typically positive SPY-VIX correlations are negative for the market in the following days).

VIX remains 5.6% below actual market volatility over the past 30 days (HV21 at 14.53) resulting in a continuation of a negative risk premium. While this is unusual it's not unheard of, especially after a recent spike in VIX like we saw in mid-April. If we get a few more low volatility days in the market HV21 will come down to about 13.75 by Thursday.

The daily SPY arbitrage model is still holding a pretty wide spread as well:

Given that the usual correlations seem to be temporarily broken and the contango spread is neutral it seems best to continue to wait it out a bit for a more profitable setup. Alternatively, if I owned XIV/SVXY I still think it's a good idea to pick up some cheap VXX calls as I mentioned via Twitter last Wednesday.


UPDATE
Performance of S&P 500 after 3 or more consecutive days of positive SPY-VIX correlation, from 3/2004 to present:

Weekly Wrap and the Week Ahead

A slow and steady week in VIX futures brought down all points along the curve with some additional emphasis on the front two months. Overall the term structure remains somewhat compressed, with just 4.7 points separating 1st and 7th month. 

There was a slight divergence in correlation between XIV and SPY today as we closed at new SPX highs - a signal for some caution in both XIV and SPX longs. From the intraday SPY arbitrage model:

Treasuries and high yield corporate bonds diverged  from SPY during the week as well, widening the gap on the daily SPY arbitrage model, with SPY trading at a $5.00 premium to the model:

And yet there's no reason VIX can't head lower given that actual volatility over the past 3 months (HV63) is just 10.8.

VIX Pushing Lower Bounds Set By Historical Volatility

Protection through the purchase of options became even cheaper today as 30-day forward implied volatility (VIX) hit 11.46 -- just 2% above actual realized volatility for the past month (HV21) of 11.24. HV21 is now also roughly equal to the actual volatility over the past three months (HV63), which as I discussed previously, can be used as a reasonable lower bounds for VIX.

Below is a view of today's HV vs IV chart from the VIX futures data page to illustrate where VIX is in relation to historical volatility (three month view):

Next is a view of VIX vs HV63 from June 2004-Present which shows how HV63 can be used as a rough approximation for the lower bounds of VIX in the immediate future under most circumstances:

And while it is possible to say that VIX is running out of room to fall given current levels of historical volatility, VIX futures are another story entirely. As the VIX futures expiration date approaches (March 20th), March VIX futures and spot VIX are likely to converge to within a couple percent of each other (discussed here). At 9% above VIX there is quite a ways for March VIX futures, and consequently VXX, to fall -- assuming spot VIX remains near its current levels.

Looking at April VIX futures, which will become front month futures used in the calculation of VXX and XIV after March expiration, you can see that they now trade at 14.7, more than 27% higher than spot VIX right now. This will provide a new catalyst for a lower VXX and higher XIV as long as VIX remains flat.

Market Wrap - 3/13

In what was otherwise a rather unremarkable sideways day in the markets, I found the movement in the underlying components of the SPY arbitrage model to be quite interesting.

Looking at the model compared to the S&P 500 (SPY) there were two arbitrage opportunities during the day and another rapid convergence of the two into the close.

Taking a look at the components level you can see the Treasury bond component (TBF) dive after strong demand for the 1:00pm 10-year auction drove up prices. As a result the model became deeply discounted relative to the SPY for most of the afternoon until a last minute rally in high yield corporate bonds (HYG) to very neatly close the gap between the S&P 500 and the model.

While the volatility component (XIV) closely tracked the S&P 500 all day, yesterday was a different story as it dragged heavily.

All in all this seems to represents some tension in the market as investors start to take increased caution and diversify a bit after what has essentially been 9 weeks of going nowhere but up for stocks.

I'd also like to point out the movement over the past 6 weeks of stocks vs the dollar index (UUP), which typically move inversely to each other. Another reason for caution in my opinion.

A Dose of Reality

Excitement from last week is continuing into this week with spot VIX (+34% today) closing well above front month futures (in fact it closed higher than 6th month futures!), a signal of market instability and a predictor of market sell offs, as I've previously discussed here.

Regardless of the "news events" that pundits say are driving the market, the reality of this market is that the FOMC's attempts to reflate an asset bubble by artificially suppressing interest rates through quantitative easing has forced everyone to chase returns in the stock market using heavy leverage. With ongoing issues of Japan's deflationary problems, Europe's insolvency and unemployment problems, and the U.S.'s deficit problem that no one is truly interested in solving, sooner or later the market will gets a dose of reality when evidence resurfaces to show once more that natural economic growth cycles, which include both growth and recession, cannot be suspended forever.  When that happens it is only natural to see some selling.

While front month VIX futures closed in a very slight backwardation today I am not rushing to buy VXX here. Over the past three days VIX has made an oversized move has risen 29.4% compared to the S&P 500's -1.85% so I will be looking to buy XIV if the market can find some support in the next couple of days.  However with front month VIX only at 17.65 there is no assurance that shorting VIX is a good play just yet. After hitting market highs after 7 straight weeks up we're likely to see choppy trading and an increase in realized volatility as traders look protect profits and perhaps try to unwind some positions.

A couple things to watch out for 1) Bernanke's semiannual testimony on the Monetary Policy Report starts tomorrow at 10:00am ET. A hawkish tone or a hint that QE is at it's useful limits could cause a bearish reaction similar to last Wednesday's selling after the FOMC minutes, and 2) The huge move in the Yen today is likely to crush Japan's stock market tomorrow and may shake investor confidence globally. Should bad news continue and the backwardation spread of M1 and M2 increase I will be long VXX.

A look at today's monster move across VIX futures:

What To Do Now? Historical Volatility Falls Under 10 As We Reach Another VIX Futures Rollover Day

VIX futures rolled over today with February futures expiring and March becoming front month. With March as front month the situation looks like this (data can be found on my market data page):

- Front month futures (M1) are 13% above spot VIX and 33% higher than actual realized volatility over the past 3 months (HV63).
- Actual volatility over the past 30 trading days (HV30) has dropped to 9.93, which is 30% lower than spot VIX
- The first month and second month (M1-M2) are in contango with a spread of -0.95, giving XIV a slight bullish bias
- The 4th and 7th month (M4-M7) are in contango with a spread of -1.8, giving ZIV a bullish bias

From the information above you can see that M1 is pretty overpriced when compared to forward volatility (VIX) and historical volatility, meaning that there is still room for XIV (inverse short-term VIX futures) and ZIV (inverse med-term VIX futures) to move higher.

However, now that we are halfway through the 7th straight week of gains on the S&P 500 and VIX futures have pressed down to levels not seen in over half a decade, I'm not finding the risk/reward in my typical XIV and ZIV trades to be justified.

There is the theory that since VIX is so low it makes sense to be long VXX (short term VIX futures). This may seem like a good idea but it is in fact a money loser 90% of the time for reasons I've previously explained here.

I've posted several trades on this blog (two January and one February), which at 13.4% have returned roughly twice that of the S&P 500 this year. At this point I feel there is little reason to chase gains at multi-year S&P 500 highs.

Which leaves me with option 3: doing nothing. I believe that you don't always have to be in a trade and it is necessary to patiently wait for an opportunity where you have a good setup. Stay tuned.

VIX Futures Weekly Wrap: New 67-Month Low in Historical Volatility (HV126)

It seems that with every week that goes by volatility sets a new record low of some sort.  This week was no exception as actual realized (historical) volatility of the S&P 500 over the past six months (HV126) hit 11.34, a 67-month low.

Spot VIX edged up on the week to 13.02 (+0.9%) while VIX futures all along the curve were pushed lower, with the spread of the term structure at the front of the curve (months 1 and 2) moving wider to -1.3 while the back end (months 4 and 7) compressed to -1.95.

Term structures:

XIV and ZIV remain bullishly biased given that the term structure is in contango and historical volatility continues to decline. As I mentioned in my article this week at Seeking Alpha, VIX can certainly move lower from here and take VIX futures and VXX with it. However, the risk/reward on inverse VIX plays such as XIV and ZIV is currently not very appealing and should be owned with extreme caution.

Weekly VIX ETF scoreboard:
- VXX:     -0.43%
- UVXY:  -1.04%
- XIV:      +0.32%
- ZIV:       +0.93%
- S&P 500: +0.31%

As a reminder, you can always see the current VIX futures term structure, past VIX futures data, and historical volatility on my VIX Futures Data page.

Just How Low Can VIX Go?

If you've been watching the markets lately and noticed that VIX has been spending some time in the 12s lately, you might be wondering just how much lower will VIX go?

Today's VIX close of 12.9 certainly sounds low but to put it in perspective let's take a look at the actual historical (realized) volatility of the S&P 500 over various time frames.

Historical Volatility (current)
Past two weeks (HV10):    6.85
Past Month (HV21):           6.20
Past 6 weeks (HV30):      11.55
Past 3 Months (HV63):    12.52
Past 6 Months (HV126):  11.49
Past Year (HV252):         12.84


Now let's take a look at the HV at a point in time 1 year ago:

Historical Volatility (as of 2/1/2012)
Past two weeks (HV10):     7.61
Past Month (HV21):            8.65
Past 6 weeks (HV30):       12.99
Past 3 Months (HV63):     21.22
Past 6 Months (HV126):   29.89
Past Year (HV252):          23.26

As you can see, the last year of trading has experienced much less volatility than the previous year. Note that the spot VIX on 2/1/2012 was 18.55, which fell in the range between HV30 and HV63 at the time. If you look at today's HV range you'll see that a VIX of 12.9  is priced at a reasonable point given the past year's levels of volatility.

Below is a graphical view of this progression of HV over the past year:

To give you one more interesting data point, let's take a look at the HV on 1/24/2007 when spot VIX closed at 9.89.

Historical Volatility (as of 1/24/2007)
Past two weeks (HV10):  6.68
Past Month (HV21):         6.82
Past 6 weeks (HV30):      6.34
Past 3 Months (HV63):    7.26
Past 6 Months (HV126):  7.35
Past Year (HV252):         9.69


So can VIX go lower? Absolutely - with another 30% to fall before reaching the 6-year low!

This is why it is critical to not assume that volatility will rise just because it is low relative to the recent past.  When trading volatility ETPs such as XIV, VXX, ZIV, and UVXY you always need to consider the shape of the VIX futures term structure and their values relative to VIX as well as historical volatility in order to make trading decisions.

VIX Futures Weekly Wrap

VIX and VXX got a little perky during the week, perhaps signalling a move higher soon, but in the end the spot VIX (+0.08%) and VIX futures edged up only slightly from a week ago along all points on the curve. Here are the term structures:

Weekly scoreboard for VIX Futures ETPs and S&P 500:
- VXX: +0.61% 

- XIV:  -1.58%
- ZIV:  -1.10% 
- SPX: +0.68% 

As of the close today all indicators for VIX trades are pretty well balanced, suggesting there aren't any multi-day trades in either direction that are likely to produce a profit with any high degree of certainty. There is still an ever-so-slight bias towards a long XIV position as mentioned yesterday but after today's large move I think it's better to wait for the next set up.

VIX Futures Weekly Wrap

We saw an unusual week of positive correlation between VIX (+3.5%) and SPY (+1.3%), a continuation of a daily occurrence of positive correlation that I identified last week.  Early in the week we also saw VIX hit its lowest close since 4/20/2007 at 12.43 before heading higher over the rest of the week.

VIX Futures Weekly Performance:

Feb-13	Mar-13	Apr-13	May-13	Jun-13	Jul-13	Aug-13
-4.1%	-7.4%	-6.7%	-5.9%	-5.7%	-5.5%	-5.3%

Front month (February), down 4.1% to 14.05, was not able to match the losses experienced by other months despite pressing down to new multi-year lows of 13.65. This resulted in a flattening of the front side of the term structure curve, reducing the negative roll yield of VXX.

Based on these changing conditions and other indicators I established a long position in VXX at $22.70 near the close on Wednesday and I continue to hold it, although I will likely ditch it Monday if it doesn't get going.

Weekly scoreboard for VIX Futures ETPs vs S&P500:
- XIV: +4.2%
- ZIV +6.4%
- SPY: +1.3%

And the daily close of the VIX Futures term structure this week:

Daily Divergence in VIX-SPY Correlation

Today the market experienced a divergence in the typical negative correlation between SPY and short-dated VIX, with SPY +0.65%, VIX +1.1%, and front month VIX futures +1.3%.  This often happens when the SPY hits new relative highs (a 5-year high for SPY in this case) as traders start buying protective puts to lock in gains, and around options expiration days (tomorrow).

From here we're likely to see more buying of short-dated VIX over the next few days as it continues to adjust, as I wrote about two days ago. This would result in a lower XIV and higher VXX. I don't typically recommend buying VXX and holding it overnight, so at this point I'm just looking for my signal to buy back XIV at a lower price.