Low Volatility Downside was the Same

In Low Volatility and Managed Volatility Smart Beta is Really Just a Shift in Sector Allocation I ended with:

“Though the widening range of prices up and down gets our attention, it isn’t really volatility that investors want to manage so much as it is the downside loss of capital.

As a follow-up, below we observe the  PowerShares S&P 500® Low Volatility Portfolio declined in value about -12% from its high just as the SPDRs S&P 500® did. So, the lower volatility weighting didn’t help this time as the “downside loss of capital ” was the same.

SPLV PowerShares S&P 500® Low Volatility Portfolio

Source: http://www.ycharts.com

The Volatility Index (VIX) is Getting Interesting Again

In the last observation I shared on the CBOE Volatlity index (the VIX) I had been pointing out last year the VIX was at a low level and then later started trending up. At that time, many volatility traders seemed to think it was going to stay low and keep going lower – I disagreed. Since then, the VIX has remained at a higher average than it had been – up until now. You can read that in VIX® gained 140%: Investors were too complacent.

Here it is again, closing at 12.45 yesterday, a relatively low level for expected volatility of the S&P 500 stocks. Investors get complacent after trends drift up, so they don’t price in so much fear in options. Below we observe a monthly view to see the bigger picture. The VIX is getting down to levels near the end of the last bull market (2007). It could go lower, but if you look closely, you’ll get my drift.

Chart created by Shell Capital with: http://www.stockcharts.com

Next, we zoom in to the weekly chart to get a loser look.

Chart created by Shell Capital with: http://www.stockcharts.com

Finally, the daily chart zooms in even more.

Chart created by Shell Capital with: http://www.stockcharts.com

The observation?

Options traders have priced in low implied volatility – they expect volatility to be low over the next month. That is happening as headlines are talking about stock indexes hitting all time highs. I think it’s a sign of complacency. That’s often when things change at some point.

It also means that options premiums are generally a good deal (though that is best determined on an individual security basis). Rather than selling premium, it may be a better time to buy it.

Let’s see what happens from here…

Top Traders Unplugged Interview with Mike Shell: Episode 1 & 2

Top Traders Unplugged Mike Shell ASYMMETRY Global Tactical Shell Capital Management

As I approach the 10-year milestone of managing ASYMMETRY® Global Tactical as a separately managed account, I wanted to share my recent interview with Top Traders Unplugged. Niels Kaastrup-Larsen is the host of Top Traders Unplugged in Switzerland. Niels has been in the hedge fund industry for more than twenty years, working for some of the largest hedge funds in the world. He asks a lot of outstanding questions about life and how I offer a global tactical strategy that is normally only offered in a hedged fund in a separately managed account. And with experience comes depth of knowledge, so our conversation lasted over two hours and is divided into two episodes.

Click the titles to listen.

Episode 1

Why You Don’t Want Symmetry in Investing | Mike Shell, Shell Capital Management | #71

“It’s not about trying to make all the trades a winner – it’s about having the average win be much greater than the average loss – and that is asymmetry.” – Mike Shell

Episode 2

He Adds Value to His System | Mike Shell, Shell Capital Management | #72

“In the second part of our talk with Mike Shell, we delve into the specifics of his program and why most of his clients have 100% of their investments with his firm. He discusses backtesting, risk management, and the differences between purely systematic systems and systems with a discretionary element. Listen in for an inside look at this fascinating firm.” – Niels Kaastrup-Larsen

Direct links:

Episode 1


iTunes: https://itunes.apple.com/us/podcast/why-you-dont-want-symmetry/id888420325?i=335354134&mt=2

Episode 2


iTunes: https://itunes.apple.com/us/podcast/he-adds-value-to-his-system/id888420325?i=335582098&mt=2


For more information, visit ASYMMETRY® Managed Accounts.

Top Traders Unplugged Interview with Mike Shell: Episode 2

Top Traders Unplugged Mike Shell ASYMMETRY Global Tactical Shell Capital Management

“In the second part of our talk with Mike Shell, we delve into the specifics of his program and why most of his clients have 100% of their investments with his firm. He discusses backtesting, risk management, and the differences between purely systematic systems and systems with a discretionary element. Listen in for an inside look at this fascinating firm.” – Niels Kaastrup-Larsen

Listen: Top Traders Unplugged Interview with Mike Shell: Episode 2


Direct links:

Episode 2


For more information, visit ASYMMETRY® Managed Accounts.

VIX® gained 140%: Investors were too complacent

Several months ago I started sharing some of my observations about the VIX ( CBOE Volatility Index). The VIX had gotten to a level I considered low, which implied to me that investors were too complacent, were expecting too low future volatility, and option premiums were generally cheap. After the VIX got down to levels around 11 and 12 and then started to move up, I pointed out the VIX seemed to be changing from a downward longer term trend to a rising trend.

As I was sharing my observations of the directional trend and volatility of VIX that I believed was more likely to eventually go up than down, it seemed that most others were writing just the opposite. I know that many volatility traders mostly sell volatility (options premium), so they prefer to see it fall.

As you can see in the chart below, The VIX has increased about 140% in just a few weeks.

VIX october

Chart courtesy of http://www.stockcharts.com

For those who haven’t been following along, you may consider reading the previous observations:

A VIX Pop Then Back to Zzzzzzzz? We’ll see

Asymmetric VIX

VIX Shows Volatility Still Low, But Trending

VIX Back to Low

The VIX is Asymmetric, making its derivatives an interesting hedge

Is the VIX an indication of fear and complacency?

What does a VIX below 11 mean?

What does the VIX really represent?

The VIX, my point of view

The VIX, as I see it…

Volatility Risk Premium

Declining (Low) Volatility = Rising (High) Complacency

Investors are Complacent


A VIX Pop Then Back to Zzzzzzzz? We’ll see

The chart and table below from Russell Rhoads at VIX Views shows an interesting visual of yesterdays increase in the VIX spot index and its futures. The chart is the VIX term structure for the VIX futures. The blue line is yesterdays term structure and the red line the day before. A term structure chart shows how the futures are priced over time. Notice the bottom goes from from left to right August 2014 to April 2015. That corresponds to the table below it, which shows the VIX (spot index) and then each months futures starting with August 2014 (the front month).

VIX Views VIX-Curve

source: http://www.cboeoptionshub.com/wp-content/uploads/2014/07/VIX-Curve.jpg

A Few Observations

The term structure shows how the curve shifted up yesterday. That is, the VIX futures increased August 2014 through April 2015 expiration dates. Notice the VIX spot index gained 27% while the August month gained 12%. When we speak of the VIX, we speak of the CBOE Volatility Index. We can’t actually trade the index, so exposure is gained through futures and options. This is a good time to point out how much the VIX spot index gained and how much less the futures moved. In the table below the chart you can see the % gain. The front month (August) gained 12.18%. The nearer months gained more than the expiration months farther out. I think Rhoads correctly points out that the options market seems to be expecting a quick pop in the VIX and then back to Zzzz. I say that because the August front month contacts gained 12% the months farther out in time had a much smaller increase in expected volatility. It’s another example of complacency. Investors aren’t so concerned about risk enough to pay up to insure it beyond this month. In this low vol environment over the pas year, increases in volatility have been quick and sharp, then revert back to lower levels. So the market seems to be following the trend that way. That works, until it doesn’t.

Let’s see how it plays out this time.


Asymmetric VIX

In The VIX is Asymmetric, making its derivatives an interesting hedge I explained how the CBOE Volatility Index (VIX) tends to react with sharper and with greater magnitude than stock indexes. There is an asymmetric relationship between stock index returns and the VIX. Below includes yesterdays action when the S&P 500 stock index was down 2% and the CBOE Volatility Index (VIX) spot gained 27%. The chart is a good visual of how, when the stock index falls, implied volatility spikes up.


asymmetric vix

source: http://www.stockcharts.com

I have been sharing some observations about the VIX recently because it had gotten do a low level not seen in many years. It’s an indication that investors have become complacent about risk. When a trend gets to an extreme, it’s interesting to observe how it all plays out.



VIX Shows Volatility Still Low, But Trending

It seemed that many of the commentators who write and talk about the VIX started talking as though it would stay down a long time. Of course, that’s as much a signal as anything that the trend could instead change.

Below is a chart of the CBOE Volatility Index (VIX) since I observed “VIX Back to Low” on July 3. It says to me that volatility, is, well, volatile. It trended up as much as 34% and then retraced much of that.

cboe volatility index vix pop

source: http://www.stockcharts.com


Looking back the past several months, we can see since the beginning of July it has started to make higher highs and higher lows. Volatility (and therefore some options premiums) are still generally cheap by this measure, but from the eyes of a trend follower I wonder if this may be the very early stage of higher vol. We’ll see…

Either way, whether it stays low or trends back up, the monthly chart below shows the implied volatility in options is “cheaper” now than we’ve seen in 7 years, suggesting exposures with options strategies may be a “good deal”.

long term vix

Volatility Risk Premium

Following up from “VIX Back to Low” I wrote last week, sure enough: the volatility index has gained 20%. Since last week it has been a good time to be long volatility and a bad time to be short volatility. Many professionals who trade volatility as their primary strategy mostly sell it to collect the Volatility Risk Premium. To do that, they have to be willing to experience gaps like this.



VIX Back to Low

It isn’t unusual for the CBOE Volatility Index (VIX) to drop before a weekend and then pop on Monday morning. That is especially true before a long weekend for those who are concerned with Theta (time decay). Since options are deteriorating assets, their value declines over time. As an option approaches its expiration date without being in the money, its time value declines because the probability of that option being in the money (profitable) is reduced. The more time to expiration, the more time it has to be profitable. With less time, the probably is lower it will ever swing high enough. Theta is a ratio of the change (relative strength) of an option price to the decrease in time to expiration.

With that said, the VIX reached its prior low today. Here is what it looks like on a daily chart:

VIX daily 2014-07-03_16-17-30

Below we zoom in with an hourly chart for a closer view:

VIX 2014-07-03_16-16-49

You may notice the last time it reached this level it gained nearly 20% quickly. The swings in implied volatility are very significant. We’ll see next week if it does it again. Or, if it is on its way to single digits.


The VIX is Asymmetric, making its derivatives an interesting hedge

Asymmetric payoff VIX

The VIX is asymmetric, its distribution is non-symmetrical, it is skewed because it has very wide swings. The volatility of volatility is very volatile. There is an asymmetric relationship between stock index returns and the VIX. This asymmetric relationship is what initially makes the VIX interesting for hedging against S&P 500 volatility and losses.

Since I started the series about the extremely low VIX level Monday, like The VIX, as I see it…, The VIX has gained 17% while the S&P 500 stock index has lost about 1%. The VIX is asymmetric. While the VIX isn’t always a perfect opposite movement to the stock indexes, it most often does correlated negatively to stocks. When stocks fall, the implied (expected) volatility increases, so the VIX increases. Asymmetry is imbalance: more of one thing, less of the other. For example, more profit potential, less loss or more upside, less downside.

An advantage of the VIX for hedging is that it is asymmetric: it increases more than stocks fall. For example, when we look at historical declines in the stock index we find the VIX normally gains much more than the stock index falls. For example, if the stock index declined 5% the VIX may have gained 30% over the same period. That ratio of asymmetry of 6 times more drift would allow us to tie up less cash for a hedge position. Of course, the ratio is different each time. Sometimes it moves less, sometimes more.

When the VIX is at a low enough level as its been recently, the asymmetric nature of the VIX makes it an interesting hedge for an equity portfolio. The best way to truly hedge a portfolio is to hedge its actual holdings. That’s the only true hedge. If we make a bet against an index and that index doesn’t move like our positions, we still have the risk our positions fall and our hedge does too, or doesn’t rise to offset the loss. I always say: anything other than the price itself has the potential to stray far from the price. But the asymmetry of VIX, its potential asymmetric payoff, makes it another option if we are willing to accept it isn’t a direct hedge. And, that its derivatives don’t exactly track the VIX index, either. None of the things we deal with are a sure thing; it’s always probabilistic.

This week has been a fine example of vix asymmetry. The chart below shows it well.


The VIX is Asymmetric

chart source: http://www.stockcharts.com


Note: The VIX is an unmanaged index, not a security, so it cannot be invested in directly. We can gain exposure to the VIX through derivatives futures or options. This is not a recommendation to buy or sell VIX derivatives. To determine whether or not to take a long or short position in the VIX requires significantly more analysis than just making observations about its current level and direction. For example, we would consider the term structure and implied volatility vs. historical volatility and the risk/reward of any options combinations.

It’s official: extreme greed is driving the stock market

In Is the VIX and indication of fear and complacency? I pointed out a few reasons I believe a low VIX level can indeed be a signal of greed and complacency and a high VIX level is a measure of fear. It’s very simple: fear and greed are reflected in the price of options. When there is a strong demand for protection, the prices goes up. When there is little demand for protection, the price goes down. The recent low levels of VIX suggest a lack of fear or desire for protection from falling prices or rising vol.

I also said that the VIX levels often correspond with other sentiment levels. I have used the Fear and Greed Index before to explain how investors oscillate between the fear of missing out and the fear of losing money. After prices rise, we observe they get more greedy. For example, if they didn’t have strong exposure they may feel regret and fear missing out. After prices fall, they are afraid of losing more money. This Fear and Greed Index is published by CNN Money and is publicly available, making it useful for this purpose to illustrate how behavior drives trends. As you can see below, the current level is “Extreme Greed”, so that is the emotion driving stocks right now.

Greed index correlates with low vix

Source: CNNMoney’s Fear & Greed index

This Fear and Greed Index includes 7 different sentiment indicators. Market volatility as measured by VIX is one of them. In observing sentiment indicators like this, we see them oscillating between extreme greed and extreme fear over time. It spends a lot of time in the middle, too, but trends often reverse when it gets to extremes. When it reaches Extreme Greed, it eventually reverses down after prices peak out and reverse down. When it gets to an extreme greed level like it is now, we eventually see something come along and surprise them. I think it’s because investors become complacent and the stunned. Change is most alarming when it isn’t expected. When stocks fall, it will move toward fear as they fear losing more money. However, these measures can certainly stay extreme for longer than you think. That is the challenge to countertrend systems and thinking: trends do tend to persist, making it more difficult to bet against the wind. But when we see levels like this, we shouldn’t be so surprised when it changes direction.



Is the VIX an indication of fear and complacency?

In Declining (Low) Volatility = Rising (High) Complacency I concluded that right when investors are the most complacent, the trend changes. Prices fall, volatility spikes up. They feel more sure about things after prices have been rising, so there is less indecision reflected in the range of daily trading. When investors feel more uncertain, they become indecisive, so the range of prices spread out. That is why I believe a VIX at low levels it is now is evidence of complacency. Complacency means a person feels smug about how things are going.

In What does the VIX really represent? I explained another reason we may consider it a measure of fear or complacency. The VIX measures the cost of insurance. When there is more buying than selling in the option market, the market is buying protection, which is an indication of fear. In fact, options are most often overpriced – their implied volatility is higher than realized volatility. Option prices often reflect the premium paid for protection because of the fear of volatility or falling prices. When the VIX is low, as it is now, the cost of insurance is low and that tells us there isn’t a lot of protection buying (fear). They don’t believe volatility will be too high in the next 30 days. Of course, it’s often when people don’t expect a thing to happen that a surprise comes along.

But one indicator by itself isn’t necessarily enough to proclaim that all market participants are complacent. The VIX measures how short-term options are priced, and most investors don’t trade options, so we could say it’s mostly options traders sentiment, although there are all kinds of options traders. However, it does tend to correspond with other sentiment indicators.

If you hear someone say that VIX below 11 isn’t a big deal and isn’t a sign of complacency, well, you may consider what that means. I just said it means people are complacent, so it shouldn’t surprise you if they are. The more doubt we hear the more it confirms the belief. And, maybe they are selling vol hoping it will stay low and keep falling.





What does a VIX below 11 mean?

It means the expected forward volatility for S&P 500 stocks is 11%. That can be compared to historical volatility and realized volatility as it plays out. The VIX is determined by how put and call options are actually priced. That is, how much volatility is priced into them. It is volatility as implied by the options price.

It means that the stock market is expected to be calm. An upward trending and calm stock market is a good thing, if it will stay that way. The stock market regime has faded from an extreme range of prices during the 2008 to 2009 period and has gotten calmer and calmer as prices have trended up. After prices trend up, investors become more comfortable and less indecisive as I pointed out in Declining (Low) Volatility = Rising (High) Complacency.

When the VIX is at such a historically low level, it may be a good time to consider options instead of the underlying. And, it may be a good time to use options to hedge.


What does the VIX really represent?

The VIX is a gauge of S&P 500 options buying and selling. It measures the cost of insurance. When there is more buying than selling in the option market, the market is buying protection, and the VIX is higher and rising. When there is more selling than buying, the market is not seeking protection. The current level is historically low, implying investors may not be seeking protection. When the VIX is up, the cost of insurance is up. When the VIX is down, the cost of insurance is down. Options on the S&P 500 stocks are generally cheap when the VIX is low and expensive when the VIX is high. We would rather sell premium when the VIX is at higher levels, buy it at low levels. That’s how I think of it.

VIX is cost of insurance

If you wait to buy insurance when a hurricane is on its way, you’ll pay a very high premium. We want to buy it when no one expects a hurricane.

Just as it’s important for a global tactical trader to understand how markets interact with each other, it’s important to understand how volatility interacts and what drives it.

The VIX, my point of view

I believe we are naturally attracted to a strategy based on our personality. I am a trend follower most of the time, until the trend gets to an extreme. That is, I identify the directional drift of a price trend and intend to go with it. If it keeps going, I’ll usually stay with it. If it reverses the other way, I’ll exit. I completed scientific research over a decade ago that led to what I believe, and I have real experience observing it. I prefer to ride a trend until the end, but I notice when they start to bend. Or, maybe when it becomes more likely.

Before it bends, I may start expecting the end. I usually notice certain things that alert me the end is nearing. If you walk outside and throw a ball into the air you may notice something happens before the ball comes back down. Its rate of change slows down: its slope changes. The line drawn with a price chart isn’t unlike a line we may draw illustrating a ball travel.

trend like a ball

So, I’m not naturally attracted to “mean reversion” as most investors would define it. I point this about because when I do deal with mean reversion its only when its meaningful. When a stock, commodity, currency, or bond drops, I don’t necessarily expect it to “go back”. I find that many people do. They think because a trend drops it will snap back. They only need to be wrong about that once to lose a lot of money. You may remember some famous money managers who kept increasing their risk as losses where mounting during the 2000 – 2003 period or 2007 – 2009 period. It not stocks it was real estate.

My beliefs and strategies aren’t based on just my natural inclination, but instead based on exhaustive quantitative research, empirical observations, and real experience. I want to determine the direction of a trend and go with it for that reason, and then take note when one goes to extreme. The VIX reaching its lowest level since 2007 is such an extreme, though it could certainly stay low for longer than anyone expects.

Some people love hearing about potential reversion, so they’ll naturally be drawn to the CBOE Volatility Index. I’ll be the first to say that is not my main attraction. My natural state is more the cool high performance Porsche that is in demand rather than the ugly car no one wants, but is cheap. Though a cool Porsche at the right price is a good thing. Demand is ultimately the driver of price trends in everything, including listed options.

When we speak of the CBOE Volatility Index we are talking about a complicated index that measures the premium paid for options on the S&P 500 stocks. Robert Whaley of Vanderbilt University in Tennessee developed the CBOE Market Volatility Index for the Chicago Board Options Exchange in 1993. He had published a paper in the Journal of Derivatives with a self-explanatory title as to the intent: “Derivatives on Market Volatility: Hedging Tools Long Overdue,” which appeared in The Journal of Derivatives.

We can talk about all kinds of pricing theories and option pricing models that drive option prices and the VIX, but at the end of the day, the driver really is supply and demand.That’s what makes it my realm of expertise.

I trade volatility, and VIX derivatives specifically, for profit and for hedging So, I am not normally a writer about it, or in options sales (like a broker), but instead a fund manager who buys and sells for a profit. When I think of volatility and the VIX, I think of how I can profit from it, or how it may help me avoid loss.

That’s where I’m coming from.

The VIX is at a point we don’t see very often, so it’s a good time to take a close look.


The VIX, as I see it…

The CBOE Volatility Index (VIX) reached a low point last week not seen since 2007 as evidenced by the chart below.


To see a closer view of the last period, below I included the last time the VIX was at such a low value. I show this to point out that the VIX oscillated between 9% and 12% for about 4 months before it finally spiked up to 20. Such a trend reversal (or mean reversion if you prefer) can take time. Imagine if the VIX stays this low for the next 4 months before a spike. Or, it could happen very soon. You may notice the VIX reached the level it is now at its lowest level in early 2007. If we believed these trends repeat perfectly, that absolute level would matter. Trends are more like snowflakes: no two are exactly the same. But in relative terms, the fact that today’s level is as low as the lowest point in early 2007 is meaningful if you care about the risk level in stocks and the stage of the market cycle.


The best way to examine a trend is to zoom in. Start with a broader view to see the big picture, then zoom in closer and closer. When people focus too much on the short-term, they miss the forest for the trees. Below is the last time the VIX was below 12. You may notice that is does oscillate up and down in a range.


The level and directional trend of the VIX matters because of the next chart. You may see a trend if you look closely. The black line is the S&P 500 stock index. The black and red line is the VIX CBOE Volatility Index. You may notice the two tend to drift in opposite directions. Not necessarily on a daily basis, but overall they are “negatively correlated”. When the stock index is rising, the volatility is often falling or already at a low level. When the stock index is falling, volatility rises sharply. It isn’t a perfect opposite, but it’s there.

VIX and S&P 500 correlation and trend

If you are interested in stock trends and the trend in volatility, and specifically the current state of those cycles,  you may want to follow along in the coming days. I plan to publish a series on this topic about the VIX, as I see it. Over the last week or so I have written several ideas that I intended to publish as one large piece. Since I haven’t had time to tie it together that way, I thought I would instead publish a series.

When a trend reaches an extreme level like this, it may be useful to spend some time with it.

Stay tuned…

if you haven’t already, you may want to click on “Follow” to the right to get updates by email to follow along. This will likely be several informal notes in the coming days.





Investors are Complacent

Implied volatility, the amount of “insurance premium” implied by the price of options, continues to suggest that investors are becoming very complacent. When the VIX is high or rising, it says the market expects the S&P to move up or down more. When the VIX is low or declining, it says the market expects the S&P 500 will not move up or down as much in the future. That is, the “insurance premium” priced into options on the S&P 500 stocks is low. That isn’t necessarily directional – it is an indication of the expected range, not necessarily direction. However, what I know about directional price trends is that after a price has been trending directionally for some time, as the S&P 500 stock index has, investors become more and more complacent as they expect that trend to continue. The mind naturally wants to extrapolate the recent past into the future and it keeps doing it until it changes. When we see that in the stock market, it usually occurs as a directional trend is peaking. Investors are caught off guard as they expected a tight range. If the range in prices widens, they probably widen even more because they are – and it wasn’t expected. Interestingly, people actually expect inertia and that is one of the very reasons momentum persists as it does. Yet, momentum may eventually move prices to a point (up or down) that it may move too far and actually reverse the other way.


If we believe the market is right, we would believe the current level accurately reflects the correct expecation for volatility the next 30 days. That is, we would expect today’s implied volatility of about 12 – 13% will match the actual historical volatility 30 days from now. In other words, 30 days from now the historical (backward looking) volatility is match the current implied volatility of 12.6%. If we believe the current volatility implied by option premiums is inaccurate, then we have a position trade opportunity. For example, we may believe that volatility gets to extremes, high or low, and then reverses. That belief may be based on empirical observation and quantitatively studying the historical data to determine that volatility is mean reverting – it may oscillate in a range but also swing from between one extreme to another. If we believe that volatility may reach extremes and then reverse, we may believe the market’s implied volatility is inaccurate at times and aim to exploit it through counter-trend systems. For example, in my world, volatility may oscillate in a range much of the time much like other markets, except it doesn’t necessarily have a bias up or down like stocks. There are times when I want to be short volatility (earning premium from selling insurance) and long volatility (paying premium to buy insurance). I may even do both at the same time, but across different time frames.

The point is, the market’s expectation about the future may be right most of the time and accurately reflect today what will be later. But, what if it’s wrong? If we identify periods when it may be more likely wrong, such as become too complacent, then it sets up a position opportunity to take advantage of an eventual reversal.

Of course, if you believe the market is always priced accurately, then you would never take an option position at all. You would instead believe that options are priced right and if you believe they are, you believe there is no advantage in being long or short them. I believe the market may have it right most of the time, but at points it doesn’t, so convergence trades applying complex trade structures with options to exploit the positive asymmetry between the probability and payoff offers the potential for an edge with positive expectation.