Everything Down, VIX Above 20: A Few Remarks

Friday, 21 June 2013

A lot could be written about the current market volatility. But time is rather scarce these days, so I post just a few remarks (which may be more for myself than for other people).

In a situation like this, it is important to take a step back, look at the big picture, and above all, not take any risks you don’t fully understand (like base your trading ideas on your predictions of future Fed actions, which even Mr. Bernanke may not be fully sure about).

When everything is moving like now, it is tempting to place bets on the hot stories, like gold, emerging markets, or the yen, even when you normally don’t trade these markets. Or it is tempting to place bets on time horizons you don’t normally do. These are often poor bets that turn to losses. As excited as I am to watch e.g. gold these days, I try to keep reminding myself not to trade it, because gold (direction at least) is not what I consider a strength of mine. I want to stay in my playing fields and I want to play safe. Just my way of course.

US Treasury Yields

The key to the whole macro situation is US treasury yields. Watch them closely. 10Y is up from 1.60’s to 2.40’s since the beginning of May. This is the fastest and most serious bond selloff since the end of 2010. Widely expected and long overdue according to many people, but still comes with a turbulence in virtually all other assets. The bonds vs. stocks (or risk assets in general) asset allocation substitution is still valid in 2013; that does not mean that the two can’t go in the same direction.

US 10Y yield

It is barely visible on long term charts, but the effects of the increase in yields can be dramatic in the short run. Using pure mathematical common sense, going up from 1.50 to 2.50 sounds more serious than e.g. from 4.50 to 5.50.

Also notice on the chart that 2.40 has been an important technical level on the 10Y.

S&P500 Technicals

From the technical perspective (if you ignore all the monetary policy and macro guesswork, which of course you shouldn’t), there has not been that much damage done on S&P500 (yet). Look at the long-term chart. Can you see a market meltdown at the end? The uptrend remains intact. At least so far.

SPX (long-term)

The market is now below the latest key 1598-1600 level. Watch that. It is still above the previous long-term all-time high (1560-1576). Watch that too.

This is an “inflection point” for a rather long-term time horizon, so don’t expect the S/R levels to “work” to the precise point. They are actually zones.


What to Do on the VIX?

I guess I don’t need to break the news that VIX got above 20…

In the last years, and especially year-to-date, shorting VIX spikes has been generally profitable more often than not. When you don’t look at any fundamental speculations, it seems to be the obvious thing to do, at least in the short-term time horizon.

If you short the VIX, you can lose, because it can go further up.

When shorting the VIX, use long puts or bear call spreads. Do not short VIX futures or VXX and the likes. This is what I believe and how I trade it. I’m not alone thinking this and many people still remember 2008 and VIX spikes to 60 or 70, which is also the reason why the expectancy (probabilities x P/Ls) might be better taking the (unwanted) long tail risks.

However, expectancy is only one factor. Other factors are skewness and your capital. Only risk losses that you can survive. Positive skewness is valuable; so is avoiding negative skewness. Therefore you pay for it. Your capital, risk attitude, trading style, and current market prices decide if it’s worth paying for it in this particular situation.