To be successful in any field we all need to keep learning. My job involves staying on top of all things index and volatility related which means I am always gaining new insights about the markets. Looking back at 2016, VIX settled into lower levels after starting the year hitting the mid-20’s as the stock market sold off. Despite the relatively tame behavior from VIX, there were some lessons to be learned last year.
Number 1 – Non-Fundamental Volatility Spikes
Before joining CBOE I was on the buy side with a variety of firms, mostly hedge funds. I was fortunate to work for some wonderful mentors. One of my first lessons was that when there’s government action that causes the markets to sell off it is often a buying opportunity. This early lesson came before volatility was a tradeable asset, but it may be applied just as easily though selling volatility. We are all aware of the volatility spike associated with Brexit as well as the overnight action that occurred with the election of Donald Trump to the Presidency. The chart below shows the overnight action for the front month VIX futures and S&P 500 futures.
Number 2 – Currency Volatility is Not Dead
The table below shows the average of several volatility indexes in 2015 and 2016. Note at the top of the list are volatility indexes based on expected price action for the British Pound (no surprise) and Japanese Yen. I think singled digit volatility bores many traders, so with the sudden increase for IV on the Pound and Yen may result in those markets getting a bit more attention in 2016.
Before moving on, I did want to highlight the long-term history for BPVIX. The chart below shows the high / low / average for BPVIX going back to 2007. Note we’ve had higher levels of IV for the Pound in the past and not just in 2008. It is very possible the higher IV may be here to stay for a while.
I know on the table above the EuroCurrency was at the low end as it was much higher in 2015. I wanted to show that IV on EuroCurrency options can reach higher levels as well by showing a 10 year history below.
Number 3 – You Can Make Money Buying VXX
This one will probably get me some hate email, but that’s what the delete button is for. VXX is more of a trading vehicle than a buy and hold asset. Admittedly if you bought VXX on the last day of 2015, put it in your pocket and held it through last Friday you would be unhappy with your performance. However, if you had been a perfect trader and exited at the 2016 high you would have turned a 48% profit. Also, as highlighted on the chart below, an overnight position on Brexit night would have resulted in a one day return of about 24%.
Number 4 – SVXY Can Be A Better Buy Than SPX
A couple of years ago, I was speaking to a CFA chapter about buying SVXY when there is a sell-off in the stock market. This was offered up as an alternative to buying the SPY ETF. I got a question as to why a portfolio manager would choose to buy SVXY when they could just purchase SPY. My response was if the stock market did not rebound, SVXY would most likely benefit from VIX and (more specifically) VIX futures moving lower. I decided to see how SVXY did relative to SPY after the market sold off in February this year. The chart with both benchmarked to 100 appears below.
I wrote the paragraph above and then created this chart. I was taken aback by the performance of SVXY from February 11th through the end of the year. Do note that SVXY was hit hard around Brexit, but otherwise put up pretty good numbers relative to the S&P 500 from the market bottom in 2016.
Number 5 – How Useful SPX ATM Volatility Can Be
CBOE now lists SPX options expiring three times a week. Typically, there are options expiring on Monday, Wednesday and Friday, but that is dependent on holidays. The chart below shows the IV of Friday expiring SPX options for the next nine weeks. I highlighted a couple of events on the horizon, notably Inauguration Day and the January Payroll report. Note the IV for SPX options bumps higher just after we get our 45th President (1/27 expiration) as those options expire that morning.
A Friendly Warning
Finally, a warning, fading volatility spikes has been a profitable method of using volatility as a trading asset for some time. As noted above it has worked quite well for several years. However, we have had periods of consistently elevated volatility in the past and are overdue for the next one. I pulled out and updated my favorite long term equity market volatility chart to highlight this point. Below is a chart of the CBOE S&P 100 Volatility Index (VXO) which has been tracking volatility using S&P 100 index option pricing for 31 years. As I typically do for volatility index charts this represents the high low and average for each year. Notice that even 2008 pales in comparison to what happened back in 1987. I just want to leave everyone with the knowledge that selling volatility has worked, but make sure you are protected when the next big unknown event hits stock prices and quickly pushes volatility to higher levels.
Finally, thanks to all the readers we have acquired over the past five years or so. Your feedback has made me a better instructor and market observer. I hope to hear from more of you in 2017 at firstname.lastname@example.org.