Link to Recording of Webinar with Bob Lang and Jay Wolberg

I was invited to join Bob Lang (options trading mentor at http://explosiveoptions.net, contributor to http://thestreet.com, and one of Jim Cramer's go-to technical experts on Mad Money) in a webinar yesterday. The recorded video has been posted online for anyone interested.

We had a great conversation, covering a wide variety of topics in 80 minutes. To help you find topics of interest, I've outlined our discussion along with approximate minute marks.

- Show intro (0:00)

- Bob's current market analysis (1:50)

- Into of Jay (10:15)

- Overview of Volatility (13:25)

- Role of actual market volatility in pricing of forward looking volatility (VIX) (17:18)

- What happens during  recent, brief VIX spikes which quickly revert; impact of QE (24:00)

- Common misconceptions of VXX (30:28)

- Reasons for large blocks of VIX calls (36:15)

- Reason why actual volatility may be higher than implied volatility (39:40)

- Reasons for a rising VIX while the market is rising (41.45)

- Likelihood of seeing a VIX in the 90s again (45:00)

- Reasons for current low VIX regime (47:50)

- Recent pattern of buying XIV on dips and likelihood of continuation of this pattern (51:05)

- Letting data guide trading decisions (53:25)

- XIV technical analysis -- importance of 200-day moving average (54:40)

- XIV indicators (57:30)

- Possibility of rally in XIV in today's market & levels to watch for Friday (1:00:10)

- Do VIX levels have influence on whether equities go up or down (1:02:00)

- Preparing for Black Swan events (1:03:45)

- Current decision making for trading XIV in market Friday (1:08:00)

- Signals for start of new rally in XIV (1:10:30)

- Why Thursday's move in XIV was an indicator that VIX was overbid (1:11:45)

- Tour of free resources at http://tradingvolatility.net (1:14:00)


If you are interested in learning more about trading options from a technical expert, check out Bob's website at http://explosiveoptions.net/ and follow him on Twitter at @aztecs99.

VXX Continues To Drive Upward

VIX and VXX continued their upward trend today with the VIX futures term structure flattening substantially, making it impossible for XIV and ZIV to make any upward progress.

We've been playing in the danger zone ever since the VXX Spike Risk gauge from our Daily Forecasts moved above 5.0 on 5/28, with VXX +16% since then. The flattening of the term structure today marks another possible shift in sentiment and puts the curve at risk of flipping to backwardation.

We're at a point where it is critical that...

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XIV: When A "Sure Thing" Goes Bad

A shift occurred in the market today with 1st and 2nd month VIX futures closing in a very slight backwardation of 0.05 points, with April at 16.65 and May at 16.60 (see data page). While this does not necessarily mean a continued selloff in XIV, I think it is very important for anyone who has grown accustomed to the seemingly unidirectional movement in XIV to understand that gains are not always a given.

We've seen a good run -- the result of a VIX that has declined from 26.66 on 6/1/12 down to six-year lows of 11.03 in March, as well as rolling futures in a contango term structure.  The result has been a staggering 200% gain over the past 9 months, and a 400% gain since 11/21/2011. It seems that money has been raining from the skies!

But remember that key drivers of VIX futures ETFs are 1) change in price of the relevant VIX futures contracts and 2) the term structure. Today we saw a shift in the flattening of the term structure which should signal a very loud "caution" to you.

When it comes to trading VIX futures ETPs it is critical to watch  for these changes in market structure.  Consider the following graph of XIV from 2004 through 2013 (prices prior to the fund launch have been by calculating the index value using 1st and 2nd month VIX futures data).

Those are some seriously painful losses! The thing that all of those declines have in common is a term structure shifting into backwardation. This is why it is so important to watch the term structure -- something that I watch daily by looking at the VIX Futures Data page (see 'M1-M2' for XIV and 'M4-M7' for ZIV) or the Daily Forecast (see the 'VXX Bias' gauge).

Exiting long XIV positions when the term structure flattens before a move to backwardation, can help you avoid these losses.



Today's closing term structure:

Tomorrow's VXX forecast: no bias from roll yield.  Spike risk remains elevated.:

Looking at the New VIX Futures Months After March Expiration

Today is the last day of trading for March 2013 VIX futures.  As discussed would happen in my week ahead post, March futures closed within about 3% of VIX.

Closing term structure:

Looking forward to tomorrow April currently sits at 15.4 and May at 16.25 resulting in a smaller contango spread of -0.85, which applies to XIV, VXX, and UVXY. With VIX at 14.39, April VIX futures are just 7% higher.

For those looking at trading ZIV, the contango spread between month 4 and month 7 will start narrower at -1.5 tomorrow.

Implied volatility has popped up a bit off of realized volatility, but with a volatility risk premium of 26% VIX pretty well priced once more. Here is the current chart from the VIX Futures Data page:

There was not much room to play in the intraday SPY arbitrage model today as the model stuck closely to the SPY.

And in case you missed it I posted about a new tool today to measure Twitter sentiment on VXX which was positive earlier in the day but is unsurprisingly heading toward 50/50 as VXX ended the day flat.

Predicting Market Sell-Offs Using the Premium of Front Month VIX Futures Over Spot VIX

Contrary to what many may think, crashes in the stock market do not just suddenly happen without warning. Subprime crash, flash crash, 2011 debt ceiling -- all of these events were preceded by existing weakness in the market prior to an actual crash event.  While it is impossible to predict when the market will fall, this measure can be used as a signal to indicate that the market is on edge, where one of many possible events can trigger a downdraft.  (There is an excellent read from Mark Buchanan (Ubiquity: Why Catastrophes Happen) which goes into depth on the topic of how something seemingly small triggers larger chain reactions.)

One of the signals that I use to determine when there is tension building in the market for a decline is to look at where front month VIX futures are in relation to the spot VIX. For reasons I will describe below, a positive premium of front month (M1) over spot VIX normally exists and converges over time. Abnormalities of this behavior indicate shifting investor sentiment.

The first concept to understand is that while spot VIX is the current 30-day measure of implied volatility of SPX options, VIX futures are the measure of the expected implied volatility on the expiration date for a given month. This means that the front month VIX futures is further out in the future than the spot VIX. Once the expiration date for the front month is reached it expires and VIX futures roll over to use the next month as front month.

The second concept is that the prices for each month of VIX futures create a curve called the term structure (you can see a visualization of the term structure in my previous post here). Normally the term structure is shaped such that VIX futures that are further out are more expensive than nearer months, a condition known as contango.  

By combining these two concepts you can see that there is usually a premium of M1 over spot VIX since M1 is further out in in the future than spot VIX and the term structure is in contango. Now since spot VIX in a constant 30-day measure of volatility and M1 is forward implied volatility on a fixed day for the next month, the amount of premium gradually decreases as we approach the expiration date.  

The chart below provides a 55 month view of the daily reading of the percentage of M1 above (or below) spot VIX. Note the periods circled in red where the value go briefly and shallowly negative followed by a spike downwards where VIX becomes much larger than M1 as the markets sell off and traders drive up the value of the spot VIX. This can be contrasted by the more confident periods in which spot VIX remains below M1 for a prolonged duration indicating a more confident market (see green "floors").

The downdrafts identified on the charts started on the following dates:

1) 9/9/2008 (subprime crash)

2) 5/6/2010 (flash crash/Greece debt problems)

3) 3/16/2011 (Libya skirmish)

4) 7/27/2011 (Debt ceiling crash)
5) TBD

As you can see, the market provides useful signals when sentiment is changing and is starting to get unstable. As market sentiment changes for the worse, you will see a gradual change in the term structure where the spot VIX rises above front month futures, a condition defined as backwardation.  There will be occasional periods of slight backwardation before a more pronounced upward move in the spot VIX which is typically accompanied by a marked downturn in the market (S&P 500). 

These movements are not just a coincidence -- it explains investor sentiment. When the general market is doing well, investors tend to get complacent and expect that it will continue to do well.  They continue to add to long positions (often with leverage) and do not have much interest in buying and holding options for protection. However these brief dips into backwardation suggest that options are underpriced and rise after a series of events remind investors of broad market risk. They start buying protective puts -- initially in smaller quantities and holding only briefly, followed eventually by broad buying of protection driving up both spot VIX and VIX futures as market risk materializes.

For VIX traders out there this means that there is an increased risk with long XIV positions and extra caution is warranted in the coming month(s).