Quite surprisingly, S&P500 had stayed in a narrow range between 1358 and 1393 for the first half of 2012 Q1 earnings season. In the last few days, it finally moved a bit higher and it is now approaching the highs from the second half of March. Fundamentally, the earnings season has been very good so far (at least relative to analyst expectations). 21-day historical volatility of S&P500 is now at 14.33% (annualized).

VIX Back in the Teens

VIX spent a total of 12 trading days (from 9 to 24 April) above the psychological level of 20. Now it is back in the teens, closing 18.74 on Friday.

VIX Futures Curve Shifts Down

In line with the down move in spot VIX, the whole VIX futures curve shifted down. On the long end of the curve, we now start to see the December 2012 contract at discount to its neighbours, which is nothing unusual (as the markets tend to expect lower volatility around the year end), but it is still worth watching in the months to come, especially as the 2012 year end futures months become more liquid.

• VIX Near 2012 Lows, VIX Futures Curve, Macro, and DST
• Low Volatility 2012Q1 Earnings Season
• VIX Contango Record Steep
• VIX Below 15, Lowest in 10 Months
• Low Volatility of VIX and End of Quarter

S&P500 lost all its March gains within mere 5 trading days between 3 and 10 April (down 4.2%, from 1419 to 1359) – the biggest decline so far in 2012. Alcoa earnings, the unofficial start of US earnings season, came after close on 10 April.

Now we are about halfway through the 1Q earnings season and so far, corporate results have been quite positive with a lot of companies having beaten analyst estimates. However, the good results were only enough to stop S&P500 from further declining, but not enough to take it back to the highs. Since 10 April, S&P500 has been moving sideways in a very narrow range between 1358 and 1393, only 2.5%. This is very low realized volatility for an earnings season, although definitely not too low in the context of 2012. Annualized 21-day historical volatility of S&P500 is just above 14% (see chart).

VIX in a New Range: 17-21

While the VIX (CBOE Volatility Index) spend most of the last two March decades in a narrow range between 14 and 17, in the last two weeks it has been moving sideways in another range, now between 17 and 21.

VIX Futures Curve Stable

VIX futures curve has been virtually unchanged in the last two weeks. The slight relative underpricing of June and July VIX futures that I have written about here (10 April) is now gone.

• Medium-Term Volatility Expectations Down; Earnings Season Starts Today
• Low Volatility of VIX and End of Quarter

S&P 500 (SPX) declined for 4 days in a row in the week before Easter and yesterday. It got close to the upper border of the resistance zone from February this year, which now becomes a support (highest intraday high was 1378.04 on 29 February). There are several meaningful levels between 1340 and 1380 which market participants may remember from 2011 or early 2012. These levels may provide some support, should the market fall further. Nevertheless, the technicals won’t be enough to save the market if we see ugly fundamentals in the weeks ahead (the earnings season that starts today, employment data and other macro, hints from the Fed, or further drama in Europe).

S&P 500 Realized Volatility

Realized volatility continues to increase from the extra lows in the first two months of 2012, but only very slowly. 21-day historical volatility of SPX is now at 11.25% (annualized).

VIX Index Leaves the 14-17 Range

VIX Index (CBOE Volatility Index – measures implied volatility of 30-day SPX options) left its narrow range of the 2-3 weeks before and yesterday it got above 18 for the first time since 8 March – almost exactly one month ago. The main themes remain the same:

• The current level of VIX seems rather low in the context of the last several years and also in the context of all the fundamental economic difficulties we are facing.
• However, SPX implied volatility remains at huge premium to realized volatility (18.81 spot VIX vs 11.25 21-day historical volatility at yesterday’s close).

Term Structure of Volatility: Expectations Change

What I find more interesting than spot VIX at this moment is the recent change in the term structure of volatility. We can see it both in the relationship of VIX and VXV (90-day version of VIX) and on the VIX futures curve.

VIX/VXV Ratio Up from Extreme Lows

VIX/VXV Ratio (see chart below) ended at 0.89 yesterday, the highest since 7 March. In general, VIX/VXV ratio tends to be higher when spot VIX is higher, and lower when spot VIX is lower. Around the middle of March we saw this ratio at extremely low levels – the lowest VIX/VXV was before the close on 16 March 2012 (0.68). In the last 2 weeks VIX/VXV Ratio came back to the area between 0.8 and 0.9 – levels quite common in history for VIX below 20.

In the end of February and at start of March, the last time VIX was about the same as yesterday (18-19), VXV was 21-22, some 3 VIX points higher than yesterday. VXV (medium term implied volatility) has underperformed VIX (short term implied volatility) in the last several weeks.

Blue = VXV; Black = VIX; Green = VIX/VXV Ratio

VIX Futures Curve Flattens

VIX futures curve flattened markedly in the last 2-3 weeks (after being extremely steep in February and early March). The distribution of the contango among individual sections of the curve also changed. One or two months ago, the curve was concave and most of the steepness could be found on the short end of the curve (there was big difference between the first and the second futures month, and between these front months and spot VIX, but much smaller differences in the more distant months). Today, VIX futures curve looks almost like a straight (but still upward sloping) line.

Compared to what it looked like before and on the relative basis (to other maturities), the middle of VIX futures curve (June, July, or August) looks quite cheap now. Of course there are big risks in VIX futures spread positions, as the short end of the curve usually moves much more than the middle and the long end.

Fundamentals This Week

Alcoa (AA) starts US earnings season after close today (we are some 100 SPX points higher since the previous earnings season started in January). The macro data release calendar is relatively quieter this week, but there will be some interesting inflation data on Thursday (PPI) and Friday (CPI) and a few others (Trade Balance, Michigan Sentiment, and – as every week – Jobless Claims). Outside the US, there will be ECB Monthly Report on Thursday, and Chinese GDP and German CPI on Friday.

• Low Volatility of VIX and End of Quarter
• Spot VIX Stable, Futures Curve Shifts Down
• VIX Contango Record Steep
• VIX Term Structure
• iPath S&P500 VIX Short-Term Futures ETN (VXX)

S&P 500 Index (SPX) held its recent gains last week, made new post-Lehman closing high (1416.51) on Monday and new intraday high (1419.15) on Tuesday. It ended the week at 1408.47 on Friday, up from 1397.11 the week before. Realized volatility continued to slowly increase from the extremely low levels that we saw in January and February. 21-day historical volatility of S&P 500 was 11.68% (annualized) on Friday.

Spot VIX Still Sideways, with Slight Expansion of Range

The sideways move in spot VIX has continued for the third week in a row. Nevertheless, the range expanded a bit to the upside in the second half of the week and we have seen spot VIX above 17 for the first time since 9 March on Wednesday and Thursday (at least on intraday basis).

Same or Very Similar VIX Closes 3 Days in a Row

Interestingly, while the VIX was quite volatile intraday, the closing values on the 3 trading days from Wednesday to Friday were within 0.03 VIX points (15.47 – 15.48 – 15.50). There were 2 occurrences in history when the VIX had exactly the same closing value for 3 consecutive days (13.42 on 18, 19, and 22 August 2005 and 13.18 on 26, 27, and 28 July 1995 – the latter was before the new methodology was introduced in 2003; the data is the backcalculated new VIX). There have been a total of 9 occasions (including the current one) when 3 consecutive VIX closes were within 0.03 or fewer VIX points – the most recent before the current one was in December 2010.

The VIX never had the same closing value for more than 3 trading days in a row.

Of course these are just a few interesting observations – I just wanted to share with you a quick analysis I did out of curiosity rather than anything else (it is not likely to provide foundation for any significant odds for the future SPX or VIX direction).

VIX Futures Curve Shifts Down

What is more meaningful for actual trading is… VIX futures curve. Although spot VIX has remained the same for 3 weeks, the futures curve has shifted down markedly in the last 2 weeks. The downward move started to gain traction around March 2012 VIX expiration 2 weeks ago – first on the short end of the futures curve (especially April and May). Last week, more distant futures months lost more value and the curve flattened (April VIX futures remained virtually unchanged last week and spot VIX even increased slightly).

Translated to human language (for those of you less familiar with VIX derivatives), the market’s expectations of next month’s S&P 500 volatility (spot VIX) didn’t change much in the last 3 weeks, but expected volatility for more distant future (the rest of 2012; VIX futures curve) decreased. Very roughly, it means that investors are now considering a bigger decline in stock prices in the next several months less likely than they did 2 or 3 weeks ago.

VXV Index Underperforms VIX

In line with declining medium-term volatility expectations, the VXV Index has significantly underperformed VIX. VXV Index measures implied volatility of S&P 500 options for the next 90 days; it is calculated using the same logic as VIX, which measures 30-day implied volatility. The interpretation (the period for which expected volatility is measured) is different for VXV and VIX futures expiring in 2-3 months, but when medium-term volatility expectations move as sharply as they have recently, the message of the two is usually in line.

VXV Index

VIX/VXV Ratio

The Week Ahead in Macro + Easter Holiday

This week is the start of 2Q 2012 and it is also the Easter week. There will be important US macro data coming out, especially nonfarm payrolls and unemployment on Friday, when major US exchanges will be closed for Good Friday Holiday. There will also be central bank monetary policy announcements in Australia (Tuesday), Eurozone (Wednesday), and the UK (Thursday). Also watch Eurozone macro data (PMI, unemployment, GDP, PPI) and, as usual, anything related to Greece, Portugal, and the debt crisis.

• VIX Near 2012 Lows, VIX Futures Curve, Macro, and DST
• VIX Futures Curve Short End Steepness and Time to Expiration Relationship
• VIX Futures Curve
• Low Volatility of VIX and End of Quarter
• VIX Contango Record Steep

After the S&P500 Index (SPX) rallied through its long-term resistance the week before and further improved its high on Monday 19 March (the new post-Lehman highest close is 1409.75), it was drifiting slightly lower or moving sideways during the rest of the week. Interestingly, we saw the same intraday performance pattern throughout the week: SPX dropped before close, overnight, and in the first minutes after open the following day, and then it was growing during most of the main session. Overall, the week was slightly negative and S&P500 didn’t manage to hold the 1400 level (Friday close at 1397.11), but stayed well above its previous resistance, which was in the 1360-1380 area.

Low Volatility of Volatility (VIX Index)

VIX Index (the measure of implied volatility of 30-day SPX options, offcially CBOE Volatility Index) recorded an unusually low volatility (= realized volatility of SPX implied volatility) during the last 2 weeks. In the last 10 trading days, we have not seen VIX above 16.70 and only two times the VIX briefly dropped below 14.

VIX Futures Curve: The New Front Month Falls Sharply

Last week, VIX March 2012 futures and options expired (last trading day was Tuesday). With the above mentioned stability of market’s volatility outlook (spot VIX), the futures curve was mainly driven by the expiration and rollovers. As April 2012 became the new front month, April futures were clearly the worst performing section of the futures curve. May and a few following months also declined more than one would have expected and as a result, part of the steepness of VIX futures curve moved from the short end to the middle of the curve.

The Week Ahead in Macro

US macro data release calendar is more interesting than the previous week, especially in the second half of the week: Durable Goods Orders on Wednesday; GDP on Thursday; Personal Consumption, Chicago PMI, and Michigan Sentiment on Friday.

Today (Monday 26 March), speeches by Bernanke (US Fed) and Draghi (ECB) are scheduled only a few hours apart.

End of Quarter

This week is the last week of 2012Q1. End of month and particularly end of quarter sometimes show very interesting and very unusual market action, as fund managers are trying to “window-dress” and improve the looks of their portfolios before writing monthly or quarterly reports to clients. Unless we’ll see a catastrophic fall this week, we can already say that the first quarter has been very generous to long-only equity investors.

• VIX Near 2012 Lows, VIX Futures Curve, Macro, and DST
• VIX Below 15, Lowest in 10 Months
• VIX Contango Record Steep
• VIX Futures Curve
• VIX Term Structure

The S&P500 Index (SPX) finally got through the 1360-1380 resistance area and even closed above 1400 on both Thursday and Friday. VIX (CBOE Volatility Index) ended the week at yet another 2012 record low at 14.47 – needless to say, SPX realized volatility has remained much lower than implied volatility that the VIX measures.

S&P500 Index

VIX (CBOE Volatility Index)

VIX Futures Curve

VIX Expiration and Record Second-First Futures Month Difference

This week, VIX March 2012 futures and options will expire (the last trading day is Tuesday).

During the last week I dedicated much attention to the relationship between spot VIX and VIX futures and the shape of VIX futures curve, which has been in a record steep contango for most of 2012. I published an analysis of the relationship between the steepness of VIX futures curve and time to expiration. One of the observations was that the difference between the first and the second VIX futures month tends to be greatest near the first month’s expiration, as the first futures month converges to spot VIX.

Market’s action at the end of the week has provided a great example, as March 2012 VIX futures (now with only 2 trading days left to expiration) significantly underperformed April and more distant months. We have even seen a new record on the second-first VIX futures month difference: It was 5.45 VIX points on Friday (16.15 and 21.60). The previous record was 5.10 on 17 August 2010. Maybe we will see even greater difference in the last two days that remain for the March contract.

Macro Data and Fundamentals This Week

The upcoming week will be relatively lighter on US macro data, but we will see some housing indicators coming out. Outside the US there will be CPI in the UK (Tuesday) and in Canada (Friday), German PPI (Tuesday), German and Eurozone PMI (Thursday), and Bank of England MPC Minutes will be released on Wednesday (the rate decision of 8 March).

Although we are way past the earnings season’s end, there will be some major companies reporting this week – among them Adobe (ADBE), FedEx (FDX), and Nike (NKE).

So What Will S&P500 Do Next?

One of the main themes of the week ahead will be whether the S&P500 will confirm its upside breakout and manage to stay above 1370-1380. Three things can happen now:

• SPX will keep on rising beyond 1400 and won’t look back any time soon.
• SPX will return to the previous resistance around 1370 and make it a support.
• SPX will return to the previous levels and fall further. Next support levels on the downside are around 1340 and around 1300.

Of course noone knows which of these scenarios will eventually materialize – plus there are lots of possible sub-scenarios and paths within each of them.

VIX Can’t Predict S&P500 Direction

Contrary to what you can sometimes hear or read, the current VIX level and the current shape of VIX futures curve give us no meaningful clue regarding future direction of equities. They only tell us that:

• Investors (market as a whole) expect realized volatility to increase in the next 30 days – or at least they are willing to pay premium for being long volatility (spot VIX higher than realized volatility).
• They expect realized volatility to increase even more in the months to follow (VIX futures curve contango) – or to be more precise, they expect future expectations of realized volatility (= future implied volatility) to increase relative to the current level.

Also keep in mind that:

• Volatility is non-directional. Although the most memorable volatility spikes occur when the market falls, volatility can also increase by large up moves (note that the largest day-to-day change on SPX in 2012 so far was up: +1.8% last Tuesday).
• The current realized volatility (as measured over the last few weeks or months) is very low compared to a longer recent period (like 2007-2012), but not really extremely low compared to an even longer time horizon (2003-2012).

• VIX Near 2012 Lows, VIX Futures Curve, Macro, and DST
• SPX & VIX: Silence before the Storm?
• VIX Below 15, Lowest in 10 Months
• VIX Futures Curve Short End Steepness and Time to Expiration Relationship
• VIX Contango Record Steep

Spot VIX Value and VIX Futures Curve Relationship

It is widely known that VIX futures curve tends to generally be in contango when spot VIX is low and in backwardation when spot VIX is high. This is in line with the mean reverting nature of VIX (and any index measuring volatility). Spot VIX and the short end of VIX futures curve tend to be more volatile than more distant futures months.

The Effect of Time to Expiration on VIX Futures Curve

The sharp VIX contango has been getting a lot of attention recently and I have seen several blog posts and pieces of analysis comparing the difference between the first and second VIX futures month, or between futures and spot VIX, to history (and I did one of my own).

There is one more factor that needs to be addressed in this kind of analysis: the time left to expiration. For example, front month VIX futures being 2.5 or more VIX points higher than the spot 4 weeks before expiration has been quite common in history, but seeing such difference one week before expiration (as we saw yesterday) is very rare.

In the analysis and charts below I focus on 3 spreads:

• The difference between the first VIX futures month and spot VIX
• The difference between the second VIX futures month and spot VIX
• The difference between the second and the first VIX futures month

I focus on the short end of the futures curve because:

• That’s where the attention of most has been in the recent weeks.
• As you would expect, the effect of time to expiration is strongest on the short end of the curve.

First Month vs Spot VIX Difference

As you can see, the difference between the front futures month and spot VIX has been in low positive numbers for most of the time. Negative (even large negative) values are not totally uncommon and typically occur when spot VIX spikes (and here not only the absolute spot VIX value is important, but also the value relative to the developments before). The lowest was -23.31 on 24 October 2008 (spot VIX 79.13). The two highest were 4.98 on 14 July 2004 (spot VIX 13.76) and 4.97 on 23.12.2011 (spot VIX 20.73).

Note that this and similar charts on this page only show time post September 2005 – since the cycle on VIX futures became pure monthly with all 12 months every year.

To complete the picture, there is another chart, showing the difference between the front futures month and spot VIX as it relates to time left to expiration:

Obviously a difference further from zero (to either side) is much more likely with more time left to expiration. On the positive difference side (relevant to the current market situation), all of the 23 largest positive differences (+3.58 to +4.98) occurred with 26 or more calendar days left to expiration.

Extremely large positive differences close to expiration occurred on 13 January 2009 (diff +3.40, spot VIX 43.27, 8 days to expiration), 14 January 2009 (diff +2.65, spot VIX 49.14, 7 days to expiration), and 16 January 2009 (diff +3.54, spot VIX 46.11, 5 days to expiration). These are the 3 biggest differences if we only take instances with 18 or fewer days to expiration.

Number 4 in this ranking is yesterday, 14 March 2012 (diff +2.49, spot VIX 15.31, 7 days left to expiration). Not regarding time to expiration and including all days in VIX futures history, it would only be rank 130.

As you can remember (or see from the spot VIX values), the current situation in the markets is very different from January 2009, making any effort to drive conclusions regarding future direction of equities or volatility based solely on the record difference tricky at least.

Second Month vs Spot VIX Difference

Here are the same charts for the difference between the second futures month and spot VIX. This is the difference I was looking at in the 27 February post: VIX Contango Record Steep.

As a short update to that post, the 4 greatest positive differences occurred in 2012: +7.02 on 17 Feb, +6.99 on 24 Feb, +6.96 on 21 Feb, and yesterday ranks 4th: +6.79 on 14 March. The greatest non-2012 positive difference was +6.76 on 20 August 2010 (spot VIX 25.49).

Time to expiration has an effect on this difference too, but (as expected) far less pronounced than on the first month vs spot. It is better visible on the positive side, because all the record negative differences occurred in the 2008 post-Lehman Armageddon, when any calendar effects were overridden by the extreme swings and broken structure of the markets (of the 17 instances when the difference was below -18, 16 occurred in October 2008 and 1 in November 2008).

So let’s look at the positive differences (the zoomed chart below is better). You can see some convergence to zero here (as with the first month vs spot difference), but it’s quite subtle. Anyway, yesterday’s +6.79 is clearly the record high for instances with fewer days to expiration.

Second vs First Month Difference

Probably the most interesting difference to look at is the difference between the first and the second futures month, because (unlike spot VIX) both are directly tradable.

The historical range here has been -21 to +5. Again, all 25 greatest negative differences (below -7.5) occurred in October and November 2008. We will again look at positive differences, which are more relevant to current market situation.

Historically, there has been only one day when the difference between the second and the first VIX futures month was greater than positive 5 VIX points. And no, it wasn’t in 2012. It was on 17 August 2010, when the front month (August 2010) was 24.35, the second month (September 2010) was 29.45, and the difference was 5.10 points. Spot VIX was 24.33. It was the last trading day of the front month contract.

As you can see from the charts below, the effect of time to expiration is inverse here. The difference between the second and the first VIX futures month is more likely to be greater (to either side) with less time to expiration. It is actually not that surprising when we look at the number of days left on a relative basis. The difference in days left to first and second expiration is 28 or 35 (4 or 5 weeks). And of course 1 day and 29 days (right side of the charts) is a more significant difference than e.g. 28 and 56 days (left side of the charts).

Conclusion

• When looking at the short end of VIX futures curve and comparing it to historical statistics, time left to VIX expiration should also be considered before driving any conclusions. The position of a particular day in the expiration cycle does matter (the closer to the short end of the futures curve you’re looking, the more it matters).
• The difference between VIX futures and spot VIX is more likely to be greater (more positive or more negative) with more time left to expiration. As expiration nears, futures converge to spot.
• The (now widely followed) first-second VIX futures month spread is more likely to be greater (more positive or more negative) close to the first month expiration.

• VIX Futures Curve
• iPath S&P500 VIX Short-Term Futures ETN (VXX)
• VIX Contango Record Steep
• VIX Near 2012 Lows, VIX Futures Curve, Macro, and DST
• VIX Options Expiration

S&P500 Index

S&P500 Index (SPX) moved sharply higher, now clearly breaking the 1360-1380 resistance. It closed at 1395.95 yesterday, at the top of the day’s range.

VIX (CBOE Volatility Index)

VIX got below 15 for the first time since 29 April 2011. It closed at 14.80 yesterday; intraday low (reached at open) was 13.99.

VIX Futures Curve

VIX futures curve moved lower again and maintained its sharp contango. VIX futures and options March contracts expire next week.

Implied vs. Realized Volatility: 15 Is Low, 11 Is Lower

However low the current VIX might seem when looking at its chart, SPX implied volatility is still significantly higher than SPX realized (historical) volatility. After having spent 30 trading days below 10%, 21-day historical volatility of SPX spiked to 11.11% yesterday, as we saw the greatest day-to-day SPX change in 2012 so far (+1.8%) – probably to remind us that volatility can increase not only when market declines, but also when it rises.

• VIX Futures Curve
• VIX Term Structure
• VIX Contango Record Steep
• VIX Futures
• VIX Near 2012 Lows, VIX Futures Curve, Macro, and DST

The struggle of S&P500 Index (SPX) with the resistance at 1360-1380 has continued to be a key topic, together with low realized volatility, high implied volatility premium, and steep VIX futures curve. Last Tuesday we saw the biggest SPX day-to-day drop in 2012 so far, but the index recovered from all its losses in the rest of the week.

S&P500 Index

VIX (CBOE Volatility Index)

VIX Futures Curve

On Tuesday, when SPX dropped and VIX spiked, the whole VIX futures curve shifted a bit higher and flattened a bit, but eventually ended the week slightly lower than the Friday before.

Macro Data This Week

There are lots of interesting macro data scheduled for this week: Retail Sales, CPI, PPI, Empire Manufacturing, Philly Fed, Michigan Sentiment, and – not least – FOMC Announcement on Tuesday. Outside the US, there will also be announcements by Bank of Japan (Tuesday) and Swiss National Bank (Thursday), and Eurozone CPI (Wednesday), which could be particularly interesting.

DST On in the US, Not in Europe Yet

For those of you looking at markets outside your timezone, note that there may be a time difference other than usual, as daylight saving time already started in some places (including the US and Canada), but not yet in some other places (including Europe). For example, the time difference between mainland Europe (CET) and New York (EST – now EDT) is 5 hours this and the next week, instead of the usual 6 hours. You can download an Excel spreadsheet with DST start and end dates for 1998-2015 in Free Downloads.

• VIX Futures Curve
• VIX Futures
• iPath S&P500 VIX Short-Term Futures ETN (VXX)
• SPX & VIX: Silence before the Storm?
• SPX Biggest Drop of 2012 So Far… the Series in Historical Context

We have just seen the biggest daily decline of the year so far on US equity indexes. It is less dramatic than it sounds, because January and February were months of extremely low volatility and there were no daily drops exceeding 1 percent on the indexes. In fact, the biggest close-to-close decline since start of 2012 had been:

• -0.69% on Friday 10 February on the SPX
• -0.76% on Wednesday 15 February on the Dow

That is history now, as SPX lost 1.54% and Dow Jones lost 1.57% on Tuesday. There were 45 trading days without a daily decline bigger than -0.69% on SPX and bigger than -0.76% on the Dow. The series started on 29 December 2011.

This low volatility series wasn’t left unnoticed by blogs and media, nor will its end. However, if we look at it from a perspective of longer history, we will see that there is nothing that special about it – and the length of the series is far from historical records (set mainly in the 1960′s).

Long Series of Days without Big Drops in History

Note: I haven’t looked at intraday volatility – only at close-to-close price changes.

S&P500

Since 1957 (the introduction of S&P500 Index), there have been 19 occasions when the index didn’t have a single daily decline exceeding -0.70% for 45 or more consecutive trading days (including the series that just ended). The longest series was 103 days and ended on 24 April 1964 (but the decline was only -0.78%). Interestingly, SPX continued more or less sideways for more than 2 months after the end of this record series.

There have been 47 occasions of 45+ consecutive trading days without declines exceeding -1% since 1957. The longest was 174 trading days, ending on 21 November 1963 with a decline of -1.30% (and -2.81% the day after).

Dow Jones Industrial Average

Let’s also look at the Dow Jones Index, which has much longer history (it started in 1896, but I only have data since 1900). There have been 32 occasions when the index went for 45 or more trading days without a decline exceeding -0.77%. The longest series had 136 trading days (that’s more than half a year) and ended on 1 February 1966. In this case, 2-3 weeks of sideways market followed, but in the end the Dow lost 4% in the month (21 trading days) following the end of the series. However, the decline on 1 February 1966 was only -0.77% and if it didn’t count, the series would be 150 trading days, ending on 21 February 1966 (-0.90%).

There have been 79 occasions of 45+ trading days without declines exceeding -1% since 1900. The longest was 155 trading days (the same series as above, ending on 1 March 1966 with a decline of -1.44%).

Is There Any Directional Bias Now?

Of course we have bearish technicals, we have Greece, and we have high implied volatility premium and VIX contango. But from a strictly historical perspective – looking at the average performance following the end of such series in the past, there is no significant directional bias. On many occasions in the past, the end of a series was followed by another series or sideways market. Overall, no difference from the long-term average performance for any period from 1 day to 3 months on.

Needless to say, the 1960′s (when many of the longest series took place) were quite a different market from the one we have now and this simple analysis is just for fun rather than anything else.

• Historical Volatility Calculator

Two weeks ago I posted a chart of S&P500 approaching a major resistance level – the high of 2011. A week ago SPX has already exceeded both the closing (Friday 24 February 2012) and intraday (Monday 27 February 2012) 2011 highs, although not by a wide margin. It has been moving sideways in the 1360-1380 resistance zone – something that of course gives us no clue about a possible future direction of US equities and global risk attitude.

Volatility and VIX Index

Realized volatility stays very low – SPX 21-day historical volatility has been below 10 for more than a month uninterrupted. So does the VIX (CBOE Volatility Index), which got back to the 17 area at the end of last week.

Implied volatility remains at big premium to realized volatility on SPX. Many people are now talking about a possible bigger correction in equities and a volatility spike, which is reflected in the prices of SPX options and VIX derivatives.

VIX Futures Curve

The story on VIX futures curve also remains unchanged, with near-record steep contango on the short end of the curve.

Silence before the Storm

The market now looks like silence before the strom. Placing directional bets on equity indexes is hard. The fact that so many people are now talking about falling equities makes it actually less likely. Given the current economic reality, it is very unlikely for volatility to remain so low for an extended period of time. However, the obvious long vol trade has already been priced in to a great extent.

And that’s the beauty of markets. In the end, you never know until it happens.

This Week’s Hot Topics and Markets

With US earnings season over, the focus will likely be on macro data (a lot of interesting employment data – especially NFP – towards the end of the week) and also the evergreens: Europe & Greece, with some flavour of oil. It will also be interesting to watch gold and silver after their last Wednesday’s huge fall.

Although in the recent years we got somehow used to big daily percentage changes in major macro markets including gold, yesterday’s fall was the 6th largest close-to-close fall since the launch of GLD in November 2004 and the second largest open-to-close fall (the one larger was 10 October 2008 with -7.1% open-to-close and -7.4% close-to-close on GLD).

GLD Chart

Distribution of GLD Returns

The following is an overview of the distribution of GLD daily returns: close-to-close, close-to-open (gap), and open-to-close (intraday). The underlying data is in percentage points, always as % of previous day close.

A few key points that the data reveals:

• Although gold was clearly trending up all the time since the launch of GLD, there were slightly more big down days than big up days (compare the 1st percentile to the 99th or the 2.5th to the 97.5th and also see negative skewness). Median close-to-close performance was +0.11%, arithmetic mean +0.08%.
• On average, vast majority of the overall appreciation of GLD can be attributed to overnight moves (gaps). Arithmetic mean is 0.075% for gaps, 0.006% intraday, and 0.081% total.
• On the other hand, many of the extremely big up moves and big down moves happened intraday rather than overnight. Compare the 99th, 1st, 2.5th, 5th, and 10th percentiles for close-to-open and open-to-close. Also note the positive skewness and very high kurtosis for intraday moves.

GLD Return Distribution since Summer 2011

The picture changes markedly if you only look at the period since August 2011 (shortly before GLD made its all-time high). You can notice a change in GLD price behaviour even by looking at a chart only, but the numbers speak more clearly.

• For most of the time since summer 2011 gold has been a consolidating, sideways, but quite volatile market. Of course the close-to-close arithmetic mean was lower (+0.038%) compared to the previous years, but the average overnight performance was still much better than intraday, which was negative (-0.044%). In fact, the average overnight move was even a bit higher than for the all time stats (+0.083% vs. +0.075%).
• GLD realized volatility (standard deviation) has been up since summer 2011 for all three periods (close-to-close, close-to-open, open-to-close). There was still very little difference between standard deviation of overnight and intraday price changes.
• There have been much fewer days with very small price changes (positive or negative – compare the 25th and 75th percentiles all-time and since summer 2011) and more days with big changes. For example, daily declines greater than 2% were about two times more frequent since summer 2011 (see 5th and 10th percentiles for all time and since summer 2011) and it was similar for big daily increases (90th and 95th percentiles).

What It Means

As usual, I won’t speculate regarding the future price direction of gold and GLD. The statistics above means just that gold/GLD in the last 6-7 months was quite different from the gold/GLD before. Differences in return distributions can have huge consequences for profitability and risk/return profiles of various option trading strategies.

VIX Futures Curve Chart

Let’s start with the chart – VIX futures curve.

• The green curve is the latest close, Friday 24 February (spot VIX 17.31)
• The yellow curve is Wednesday 15 February, the highest spot VIX close in February (21.14)
• The blue curve is Friday 3 February, the lowest spot VIX close in the first half of February (17.10) and the last time when spot VIX was at about the same level as now
• The first mark on each curve is spot VIX, the others are individual futures contract months.

Historical Perspective

Since the introduction of VIX futures there have been 14 instances when the difference between the second nearest futures month and spot VIX was 5 or more VIX points.

A situation when the difference was above 5 for several days (as we have seen recently) is considered one occurrence, unless there were 11 or more consecutive trading days with the difference below 5. The date is always the very peak (the day when the difference was highest).

You can see more details in the table below.

• 0–2 = Second futures month less spot VIX (difference in VIX points)
• Days = Days left to second futures month expiration
• Final Sett = second futures month final settlement value
• Perf = Second futures month change from now to settlement

Note that in July 2004 (occurrence 2) there were 126 days left to expiration, because the VIX futures cycle was not purely mothly then as it is now. I have included this occurrence for completeness.

What It Means

Although the first VIX futures contango interpretation that comes to mind is that the market expects volatility to go up, you can see that in all but 2 occurrences VIX futures actually ended lower at expiration (and often even below the original spot VIX).

Does it mean that shorting 2-month-ahead VIX is a good idea under these circumstances? It might be, but…

• The sample is too small to draw any statistically significant conclusions.
• I have only looked at the difference now and at expiration – not what happens in between.
• Occurrence 7 is a big warning – when volatility increases, it sometimes increases big way.

After all, it would be a short volatility trade. The probability of profit is high, but so is the long tail risk. Maybe we can look at VIX options (April 2012) – but that’s beyond the scope of this post.

• VIX Futures Curve
• SPY Correlation to Currency ETFs at Record Highs
• iPath S&P500 VIX Short-Term Futures ETN (VXX)
• VIX Term Structure

The correlations were calculated from daily returns over a 6 month rolling window (126 trading days to be precise). If you are not familiar with the concept of correlation, you can see basic interpretation here.

Correlation of SPY and FXE

The correlation between SPY and FXE (CurrencyShares Euro Trust ETF, tracking EUR/USD exchange rate) reached 0.75, highest since FXE introduction back in December 2005. This probably reflects the fact that it is news from Europe what’s getting the headlines and driving short-term sentiment on global markets in these days (typical scenario: good news from Greece & Eurozone, EUR/USD rises, equities rise vs. bad news, EUR falls, equities fall).

SPY Correlation to FXB and FXF

The correlation of SPY to FXB (ETF tracking the value of British Pound) and FXF (Swiss Franc) also increased.

Correlation of FXE and FXB, FXF

The correlation between FXE and FXB has been showing a very steady high positive level for years, not leaving the 0.50 to 0.80 range.

Not surprisingly, Swiss Franc is historically even more tightly correlated to the Euro, with FXE-FXF correlation above 0.80 for most of the last several years. However, 2011 was an exception, as Swiss Franc decoupled from the Euro and became a very specific story of its own, with its sharp appreciation in Q2 and July 2011, speculations concerning possible interventions by Swiss National Bank in summer, and the actual act by SNB in early September (on 6 September the SNB announced a minimum EUR/CHF rate of 1.20 which it intended to protect through buying foreign currencies “in unlimited quantities”).

SPY-FXY Correlation Up from Negative Territory for the First Time

Over years we were used to seeing Japanese Yen (once rare at being a virtually zero interest currency) moving in the opposite direction to equities and risk assets. This has not been the case in the last several months, at least according to correlation statistics of SPY and FXY (Japanese Yen ETF). For the first time since the introduction of FXY ETF in February 2007, the correlation of daily returns of SPY and FXY measured over a 6 month period got above zero, standing at 0.21 on 17 February market close. This of course is still too low to be really called positive correlation, but the traditional negative correlation is gone, at least for a while. The fundamentals and news coming from the Japanese economy have also shown a rather mixed picture recently (debt, trade balance, the 2011 earthquake) and it will be very interesting to watch the Yen and its relationships to other macro markets in the coming months. Maybe there will be a very different Yen.

Correlations of SPY to FXA and FXC Remain High

Correlations of SPY to FXA (Australian Dollar ETF) and FXC (Canadian Dollar ETF) have been high for several years. AUD and CAD (together with NZD and contrary to the above mentioned JPY) are currencies of commodity exporting countries and they have historically shown tight correlations to commodity prices and risk assets in general. FXA and FXC have also been tightly positively correlated to one another.

SPY-UUP Correlation at Record Low

Having seen the charts above, it is no surprise to see the correlation of SPY and UUP at record low levels (-0.77). UUP is an ETF tracking the US Dollar Index, an index measuring the value of US Dollar relative to a basket of six other currencies (EUR with share over 50%, JPY, GBP, CAD, SEK, and CHF).

• Correlation

The S&P500 Index has now approached the highs of 2011 and of the whole bull market which started from the deep March 2009 low. This is a very significant resistance level. Note that this level also matches two yearly lows back in 2007. This level is the absolute key feature to watch on major US equity indexes from a technical perspective and any valid breakout or reversal can have huge effect on other macro markets and on the general risk on vs risk off trade.

There were 3 major tops in 2011:

• 1344.07 on 18 February 2011
• 1370.58 on 2 May 2011, high of 2011, the blue horizontal line on the chart
• 1356.48 on 7 July 2011

These were intraday highs. The highest 2011 close was 1363.61 on 29 April (the Friday before Monday 2 May). Last Friday SPX closed at 1361.23 = 2.38 points (0.15%) short.

With SPX above 1360 now, the two lower 2011 tops were already surpassed and the absolute intraday high of 1370 is very close (less than 1% in SPX and easy to be reached on any day).

We have now seen two months of virtually uninterrupted up move in the SPX (the last bigger correction was in mid December). The uptrend in SPX is now in a danger zone, where the probability of a bigger downside correction is high.

S/R Levels are Actually S/R Zones

Keep in mind that support and resistance levels are zones rather than exact price points, especially those seen on longer time frames. It is perfectly possible for the SPX to break through 1370 to the upside and continue higher for a few percent before reversing (this is quite common on the SPX). It is also perfectly possible for the reversal to occur before the exact 1370.58 price is reached. Not least, it is also perfectly possible for the SPX to continue higher without a bigger correction, although some resistance or sideways action in the 1360-1380 area is very likely.

How the Resistance Looks on the Other Indexes

Dow Jones Industrial Average

The high of 2011 (12876) was already tested on the Dow. On Friday the index closed 74 points higher. Any continued up move will certainly require the highs being breached on S&P500 too.

NASDAQ Composite

NASDAQ Composite looks most bullish of the three closely related major US indexes. Like on the Dow, 2011 highs have already been breached and the index closed at 2951.78 on Friday, 2.2% higher than the maximum of 2887.75 from May 2011. Furthermore, these highs also exceed those from 2007 and we are now seeing the highest levels on NASDAQ since early 2001.

What It All Means

So will stocks go down now or will they keep going up? Noone knows. There are good fundamental reasons for either. We’ll leave the predicitons to the analysts. In any case, watch the SPX 1360-1370 level closely.

There may be some continued sideways action (like we have seen on Friday already). There may be sharp short-term reversals, false breakouts, and corrections. A resistance level of this significance rarely stays unnoticed even by a smoothly rallying market (remember gold at 1000?).  When it does, that’s very bullish.