Tesseract
3rd March 2013, 01:03
Hi All,
I have been doing some research on the volatility index(s) and I wanted to share with you a few thoughts. Some may consider financial subject matter utterly boring... However volatility is the antithesis of boring if you think about it, which is perhaps why it captured my interest and perhaps the interest of anyone else who is, dare I say it, somewhat anarchical. At any rate, this field is truly the domain of those whom we variously refer to as: ‘the elite’, ‘TPTP’ and even, most dramatically, ‘the cabal’. Therefore it would not be a bad thing for us to understand it a little better than we currently do. At the end of this, I will have turned some theories on their heads and I will ask the question: have we been mislead? And, if so, has this been deliberate?
Firstly some background facts:
1) In the USA stock market volatility (specifically the part of the stock market which is the S&P 500) is forecast by the volatility index (VIX).
2) Although the VIX is not a stock, derivative assets have been created that essentially allow VIX to be traded as if it were a stock.
3) The asset types that exist for this are (at the least) futures and options contracts.
4) The algorithm that generates and constantly updates the VIX value is the property of the Chicago Board Options Exchange (CBOE).
5) Although the VIX is officially pertinent to the S&P500 there is no reason why it can’t be used as a portent for other indices and stock markets.
Now the interesting details... VIX is a volatility index, so ostensibly it significantly rises when there is a big shift in the markets (either gain or loss). I use the word ostensibly because this is in fact not the full truth. The VIX index makes its biggest upward movements when the stock markets undergo a significant correction or a crash. When markets are in a strong bull-run, making strong gains, the VIX does not respond with a great upward spike, it actually goes down – contrary to what one might expect. The VIX therefore has what you might call a bear-market bias, or is a fear indicator. If you look below at the overlayed charts of the S&P500 and the VIX you will see that the impressive VIX spikes historically have occurred when S&P500 goes down severely.
20684
When the S&P 500 goes down, and VIX spikes, there is an interesting disparity between the relative strengths of the two movements. For a mild movement down in the S&P, the movement up in the VIX is disproportionately high. Please see inserted figure.
20685
20686
This historically proven behavioural characteristic of the VIX has endowed it with a special power as a potent hedge against market sell-offs. To illustrate; if a punter had invested heavily in several stocks, being firmly of the opinion that they will rise, the same punter should also invest, as a contingency measure, a relatively small amount of money in VIX derivatives. If the conventional stocks rise, he profits – losing only the price of his VIX contracts (a pittance). If the stock market crashes he loses big time on the stocks, but his relatively small investment in VIX makes disproportionately large gains, which allows him to approximately break even.
Moving along to our own sphere of awareness. Most of us know, through Avalon or elsewhere, of the fact that a mysterious investor has gambled approximately $11M in VIX call options. This means that if VIX goes up, that investment pays a profit. Because of the natural leverage in options, it could be an enormous profit. Firstly, based on what I have written above, we should understand that this is really a bet that the markets will correct (or crash, if you like theatrics) – it is not a bet that the market will go ‘up or down’, it is firmly a bet that the market will go down.
Now, we need to consider the likelihood that this $11M VIX call is actually a hedge, since that is the mainstay of VIX. If this is the case, then what the $11M mystery investor is really betting on is a rally in the markets occurring between the time he bought the calls, and April – when they expire. The exact opposite of what we are all being lead to believe. Again, if this is true, the magnitude of money invested in the markets probably dwarfs the amount that was put into VIX. If this is true, the investor probably has taken out call options on the market which would leverage the investment significantly. Overall, his potential for profit is enormous. It would also mean that the investor’s overall bet is well into the 10s or maybe even over 100 million dollars, so while $11M might be unimpressive to some, a broader strategy of $100M is something more to behold. The same investor probably has other holdings rather than placing all in this one basket – meaning that chances are we are talking about a billionaire here (not that such creatures are rare these days).
It could be inferred that the investor does not have confidence in the markets after April, the date which he has to exit his positions. So, maybe the entropyphiles amoung us should be thinking After April, not Before April.
So, with regard to all the hype about the VIX call, have we been mislead? And, if so, has this been deliberate?
Note: I may edit this as I learn more – posting now in haste as time is of the essence.
I have been doing some research on the volatility index(s) and I wanted to share with you a few thoughts. Some may consider financial subject matter utterly boring... However volatility is the antithesis of boring if you think about it, which is perhaps why it captured my interest and perhaps the interest of anyone else who is, dare I say it, somewhat anarchical. At any rate, this field is truly the domain of those whom we variously refer to as: ‘the elite’, ‘TPTP’ and even, most dramatically, ‘the cabal’. Therefore it would not be a bad thing for us to understand it a little better than we currently do. At the end of this, I will have turned some theories on their heads and I will ask the question: have we been mislead? And, if so, has this been deliberate?
Firstly some background facts:
1) In the USA stock market volatility (specifically the part of the stock market which is the S&P 500) is forecast by the volatility index (VIX).
2) Although the VIX is not a stock, derivative assets have been created that essentially allow VIX to be traded as if it were a stock.
3) The asset types that exist for this are (at the least) futures and options contracts.
4) The algorithm that generates and constantly updates the VIX value is the property of the Chicago Board Options Exchange (CBOE).
5) Although the VIX is officially pertinent to the S&P500 there is no reason why it can’t be used as a portent for other indices and stock markets.
Now the interesting details... VIX is a volatility index, so ostensibly it significantly rises when there is a big shift in the markets (either gain or loss). I use the word ostensibly because this is in fact not the full truth. The VIX index makes its biggest upward movements when the stock markets undergo a significant correction or a crash. When markets are in a strong bull-run, making strong gains, the VIX does not respond with a great upward spike, it actually goes down – contrary to what one might expect. The VIX therefore has what you might call a bear-market bias, or is a fear indicator. If you look below at the overlayed charts of the S&P500 and the VIX you will see that the impressive VIX spikes historically have occurred when S&P500 goes down severely.
20684
When the S&P 500 goes down, and VIX spikes, there is an interesting disparity between the relative strengths of the two movements. For a mild movement down in the S&P, the movement up in the VIX is disproportionately high. Please see inserted figure.
20685
20686
This historically proven behavioural characteristic of the VIX has endowed it with a special power as a potent hedge against market sell-offs. To illustrate; if a punter had invested heavily in several stocks, being firmly of the opinion that they will rise, the same punter should also invest, as a contingency measure, a relatively small amount of money in VIX derivatives. If the conventional stocks rise, he profits – losing only the price of his VIX contracts (a pittance). If the stock market crashes he loses big time on the stocks, but his relatively small investment in VIX makes disproportionately large gains, which allows him to approximately break even.
Moving along to our own sphere of awareness. Most of us know, through Avalon or elsewhere, of the fact that a mysterious investor has gambled approximately $11M in VIX call options. This means that if VIX goes up, that investment pays a profit. Because of the natural leverage in options, it could be an enormous profit. Firstly, based on what I have written above, we should understand that this is really a bet that the markets will correct (or crash, if you like theatrics) – it is not a bet that the market will go ‘up or down’, it is firmly a bet that the market will go down.
Now, we need to consider the likelihood that this $11M VIX call is actually a hedge, since that is the mainstay of VIX. If this is the case, then what the $11M mystery investor is really betting on is a rally in the markets occurring between the time he bought the calls, and April – when they expire. The exact opposite of what we are all being lead to believe. Again, if this is true, the magnitude of money invested in the markets probably dwarfs the amount that was put into VIX. If this is true, the investor probably has taken out call options on the market which would leverage the investment significantly. Overall, his potential for profit is enormous. It would also mean that the investor’s overall bet is well into the 10s or maybe even over 100 million dollars, so while $11M might be unimpressive to some, a broader strategy of $100M is something more to behold. The same investor probably has other holdings rather than placing all in this one basket – meaning that chances are we are talking about a billionaire here (not that such creatures are rare these days).
It could be inferred that the investor does not have confidence in the markets after April, the date which he has to exit his positions. So, maybe the entropyphiles amoung us should be thinking After April, not Before April.
So, with regard to all the hype about the VIX call, have we been mislead? And, if so, has this been deliberate?
Note: I may edit this as I learn more – posting now in haste as time is of the essence.