VIX Concerns and Accumulation/Distribution Correlations

[Billy]

FWIW, please find hereafter a few of the comments I made replying to some members’ questions by email this weekend:

What concerns me the most currently is the VIX apathy during the decline. The VIX spikes during panics usually reflect ST aggressive hedging by big institutions who prefer to hold most of their long positions with an insurance instead of actually selling their huge positions. The nasty decline of prices on heavy volume without any true VIX spikes do suggest to me that the big sharks are really unloading massively their long positions like they haven’t done during all prior corrections since 2009. The TEV on inverse ETF’s also lacked any spike contrary to the usual correction norm. Large players perhaps simply don’t need to hedge aggressively anymore because they already sit on a lot of cash. All my correlations studies of the indices with the Acc/Distr ratings are also pointing to an obvious overdue bounce which COULD hit up to the 20 SMA’s. But that will probably be just another short-covering reaction to Friday’s OPEX technical levels/targets without any meaningful follow-through.

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This last correction points to a change in character of institutional behavior that was not present in all prior corrections. For whatever reason, they are clearly in a fresh selling mood and betting on much lower prices to come so I doubt that they will accumulate aggressively at current levels. In case of a Thanksgiving bounce, I’d be very careful from the post-THX Monday onward and ready to short aggressively in case of renewed high-volume declines. The best now is to trade small options positions day by day and consider the indices’ 9EMA’s and 20 SMA’s as the most likely spots where the trends could reverse if we see volume spikes near those dynamic resistance levels. For GDX, the 9 EMA is particularly important after reviewing prior corrections.
Billy

[Timothy Clontz]

Billy,

On a superficial level this reminds me of 2006, but I've not studied the VIX in any real depth. Is there a difference I'm missing that I could learn here?

Thanks.

Tim

[Billy]

Billy,

On a superficial level this reminds me of 2006, but I've not studied the VIX in any real depth. Is there a difference I'm missing that I could learn here?

Thanks.

Tim

Dear Tim,

Let me first thank you for your fantastic posts! They are really stimulating the mind.

The comparison between SPX in 2006 and SPX in 2012 does not show a very similar pattern but the VIX does and it underlines my point.

In both years, SPX rose from January to April/May, then experienced a correction bottoming in June. The similarity ends here because SPX rallied up relentlessly until year-end in 2006 while it is in deep correction since September 2012.

So the VIX pattern trending lower from June to December in 2006 was a “normal” one during a sustained market rally while the almost identical pattern in 2012 is not normal during a correction. As Dave Landry wrote this morning in his newsletter : “The Vix, which measures fear and complacency, didn't even wake up on the last leg down. I don't look at the Vix every day, but when I do, I have a Dos Equis. Seriously, the Vix only matters when it matters. And now, I think is one of those times.”

On a side note, notice that the CBOE implied correlation index does also exhibit a very strange resilience to jumping higher in the current correction. Deducting from the maths usesd in the making of that index, currently, hedge funds do not use options strategies to protect themselves from a general market freefall but only for about half of the SPX stocks. This is unprecedented too since 2009 and could mean that they have already unloaded half of their long term positions (AAPL comes to mind). I think that I am just using basic logic here and you don’t need to be an expert on the VIX or correlation to reach the same conclusions.
Billy
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[lulzasaur]

Hello all,

I just wanted to share something I found on another board (Daneric's Elliott Waves):

http://mediacdn.disqus.com/uploads/mediaembed/images/386/5749/original.jpg

"The study says the set up we saw friday of SPX & VIX is not as rare as we initially(or those here) thought. In fact the study shows there were 11 such instances this occurred and were clustered around other major market lows." - VII

link: http://danericselliottwaves.blogspot.com/2012/11/e-minis_18.html#disqus_thread

This is just another observation though.

[Timothy Clontz]

...for both the explanation and the kind words! :-)

I had always thought of the VIX dropping during a correction as a sign of complacency -- kind of contrarian.

But your post adds a whole new twist to it, because it could ALSO mean that options aren't being used to protect long positions... if those long positions THEMSELVES are being unloaded.

It seems to me that there might be a way to parse the difference between low VIX optimism (i.e. few options but plenty of long positions) versus low VIX pessimism (i.e. few options NEEDED because the long positions are being unloaded).

If a correction has a low VIX AND low market volume, that might be more optimistic for a bounce than a low VIX and high market volume because that would mean they aren't even bothering to keep the long positions and therefore don't have anything left they need to protect.

[Billy]

...for both the explanation and the kind words! :-)

I had always thought of the VIX dropping during a correction as a sign of complacency -- kind of contrarian.

But your post adds a whole new twist to it, because it could ALSO mean that options aren't being used to protect long positions... if those long positions THEMSELVES are being unloaded.

It seems to me that there might be a way to parse the difference between low VIX optimism (i.e. few options but plenty of long positions) versus low VIX pessimism (i.e. few options NEEDED because the long positions are being unloaded).

If a correction has a low VIX AND low market volume, that might be more optimistic for a bounce than a low VIX and high market volume because that would mean they aren't even bothering to keep the long positions and therefore don't have anything left they need to protect.

Exactly ! You found the perfect wording for what I was trying to convey. Now, it could even become worst than that if they are simply net short and hedging with calls rather than with puts since the VIX only tracks put options volatility.
And cheers for your baby!
Billy

[Timothy Clontz]

I think I understand the VIX a lot better now, and I appreciate it!

[pete]

Exactly ! You found the perfect wording for what I was trying to convey. Now, it could even become worst than that if they are simply net short and hedging with calls rather than with puts since the VIX only tracks put options volatility.
And cheers for your baby!
Billy

fascinating conclusion for whats going on under the surface, never seen it from that point of view.

as far as i got the VIX calculation, it uses both, nearterm puts and calls.
if net shorts would hedge with calls, then the call side should add to the calculation similar in VIX direction than puts for long protection, so the VIX should rise again?
am i missing here something on the put side?

[mnoel]

Here is a link leading to the VIX calculation. http://www.cboe.com/micro/vix/vixwhite.pdf

Thanks to all for these very valuable comments.

Regards,

Martin

[Billy]

fascinating conclusion for whats going on under the surface, never seen it from that point of view.

as far as i got the VIX calculation, it uses both, nearterm puts and calls.
if net shorts would hedge with calls, then the call side should add to the calculation similar in VIX direction than puts for long protection, so the VIX should rise again?
am i missing here something on the put side?

Pete,
You are right. I should have checked back the VIX calculation before writing the obviously wrong “VIX only tracks put options volatility”.
What I really had in mind was the usual interpretation of spikes in the VIX as being reflective of hedging of long positions in reaction to fear of a falling market by investors. Fear is pure emotion and then, yes it would be rational to interpret the VIX spikes as potential market bottoms. But such a widespread interpretation can prove totally wrong if under the hood the VIX spike is due to hedging of net short positions with calls. The “fear” would then lead to emotionally protecting from a rally and It could rationally mark a temporary top in a downtrend.
So, the current apathy in the VIX can mean an emotionally balanced market with as much fear of missing a new rally as of missing a new down leg. After all, isn’t Mr.Market the champion for fooling the most people most of the time?
Billy

[ilonaross]

http://www.zerohedge.com/news/2012-11-20/largest-weekly-inflow-bank-savings-accounts-record-flashing-red-alarm

Could this have any relevance?

[Billy]

http://www.zerohedge.com/news/2012-11-20/largest-weekly-inflow-bank-savings-accounts-record-flashing-red-alarm

Could this have any relevance?

Ilona,
Thank you but this has no direct relevance with VIX or institutional activity.
Billy

[pete]

Pete,
You are right. I should have checked back the VIX calculation before writing the obviously wrong “VIX only tracks put options volatility”.
What I really had in mind was the usual interpretation of spikes in the VIX as being reflective of hedging of long positions in reaction to fear of a falling market by investors. Fear is pure emotion and then, yes it would be rational to interpret the VIX spikes as potential market bottoms. But such a widespread interpretation can prove totally wrong if under the hood the VIX spike is due to hedging of net short positions with calls. The “fear” would then lead to emotionally protecting from a rally and It could rationally mark a temporary top in a downtrend.
So, the current apathy in the VIX can mean an emotionally balanced market with as much fear of missing a new rally as of missing a new down leg. After all, isn’t Mr.Market the champion for fooling the most people most of the time?
Billy

Billy,

looking around a little regarding volatility behaviour:

On a shortterm view i found larry connors vix 5% rule compared to the 10d SMA of VIX in his 2009 book.
If below 5% of the SMA, sell the S&P, good for 5 days and vice versa.

What i found pretty interesting was the behaviour in the period August-September 2011 in the Gold volatility GVZ, similar calculated to the VIX:
http://stockcharts.com/h-sc/ui?s=GLD&p=D&yr=3&mn=0&dy=0&id=p32628808138

just a little food for thought

[Billy]

Billy,

looking around a little regarding volatility behaviour:

On a shortterm view i found larry connors vix 5% rule compared to the 10d SMA of VIX in his 2009 book.
If below 5% of the SMA, sell the S&P, good for 5 days and vice versa.

What i found pretty interesting was the behaviour in the period August-September 2011 in the Gold volatility GVZ, similar calculated to the VIX:
http://stockcharts.com/h-sc/ui?s=GLD&p=D&yr=3&mn=0&dy=0&id=p32628808138

just a little food for thought

Pete,
Very interesting indeed. Your GVZ link seems to illustrate one of these cases of a “capitulation”” volatility spike at a top instead of at a bottom.
Billy