Week in Volatility

Equity markets were up as the uncertainty about Japan seem to resolve, and volatility markets were down. Implied volatility in the VIX options also fell, and skew has declined significantly. While I think the thread of radiation leak and consequences are still a real possibility, VIX and VSTOXX do not reflect it as an issue. My plan is to trade defensively this week, adding gamma whenever seems reasonable.




GVZ futures had their debut on Friday, trading a total of zero contracts. I created a plot using settlement values. I really hope that CBOE will figure out a way to bring liquidity into the product, but I'm pessimistic that it will happen.

Gold VIX (GVZ) Futures, Part 2

Gold VIX futures are set to start trading today. Although afaik there is no lead market maker for the product, and I expect the markets will be wide, and probably no trades will be made, I really hope that the product will be a success.

Here is my attempt to forecast where GVZ futures may open - in the first model I normalized historical prices of GVZ and VIX over the same period, and applied current VIX futures premium over historical price to the GVZ. The second model I did the same to yesterday closing prices of GVZ and VIX.

Symbol	Model1	Model2
GV K1	19.70	20.60
GV M1	20.50	21.43
GV N1	21.05	22.00
GV Q1	21.40	22.30
GV U1	22.00	22.95

These forecasts are very simplistic, but may be a reasonable indication of where the futures will open. Unfortunately it looks like my software platform does not have GV futures enabled ...

Gold VIX (GVZ) Futures

As CBOE announced earlier the launch of futures on GVZ for this Friday - March 25th, however recently CFE issued a memo about extending the deadline for LMM program for futures until May 2nd. I assume that not many, or most likely no one stepped up to the LMM role because of the previous failures of volatility products like Russell,Dow, and Nasdaq volatility futures, as well as failure of CME to attract liquidity to their GVX Gold VIX futures. However I don't think that the launch of futures will be postponed until later date. Unfortunately, there's probably won't be any liquidity in the contracts until someone steps up into LMM role.

According to CFE 5 contracts will be listed:

Symbol	Last Trading Day	Expiration Day
GV K1	MAY 17 2011	MAY 18 2011
GV M1	JUN 14 2011	JUN 15 2011
GV N1	JUL 19 2011	JUL 20 2011
GV Q1	AUG 16 2011	AUG 17 2011
GV U1	SEP 20 2011	SEP 21 2011

VIX forecast? There is no forecast!

In the last few days volatility blew through my expectations to levels that we have not seen in months. VIX expired at 25.14, up 8.65 since last expiration, and VSTOXX finished at 35.23 up from 19.19 last month. This is significantly higher than the forecasts I made. With this recent volatility I'm sure everyone is trying their best to forecast where the VIX will go next. However I think is it prudent to remember that there are limitations to our forecasting ability - the situation in Japan that currently holds market's attention, or its ultimate influence on economy and the market is highly uncertain. I think this is a fair warning - now my "forecasts" for next expiration are: VIX at 23.36 vs 24.90 in the futures, VSTOXX at 28.30 vs 26.80 in the futures. Good luck traders, and hedge your deltas!

Week in Volatility

Markets were down this week, but while volatility futures rose implied volatility did not rise significantly. With significant uncertainly regarding the situation in Japan, US markets seems to ignore it, and instead focus on economic growth and iPad 2 sales. My feeling is that a lot of uncertainly is actually going to be resolved this week, and I expect to see lower risk premiums.

Can one beat a random walk?

I came across a very interesting post on Intelligent Trading blog titled "Can one beat a Random Walk-- IMPOSSIBLE (you say?)" The author suggests that there is a trading strategy that will generate profits on a random walk, and provides R code for such strategy, as well as link to a mathematical explanation.

Lively discussion has emerged in the comments, with people debating whether the strategy is correctly implemented, and if it can be applied to the real world trading instruments to generate profit. Unfortunately I think the author made a small mistake confusing returns with prices, and the mathematical rule that he is using cannot be applied for profitable trading even in theoretical world.

The author at Intelligent Trading uses the "75% rule" to predict the next in the series of returns or actually what the author thinks are returns, but in reality return increments. The first time I have heard of 75% rule was from a paper by D. Sornette (author of Why Stock Markets Crash) and J.V. Andersen. (I don't have the access to the book referenced in the Intelligent Trading blog to compare the math) The title of the paper succinctly summarizes the finding: "Increments of Uncorrelated Time Series Can Be Predicted With a Universal 75% Probability of Success," but if you want all the details you can download the paper from arxiv.

The paper explains that signs of increments of uncorrelated times series with symmetric sign distributions are predictable with probability of 75%. In layman terms this can be explained as follows - if a stock was down today, there is a 75% chance that tomorrows return will be higher than todays; if a stock was up today, there is a 75% chance that tomorrows return will be lower than todays. Unfortunately the rule does not apply to signs of the next day returns, so it cannot tell you whether the market will be up or down tomorrow.

In the code provided at Intelligent Trading the author simulates trading in these return increments which are predictable, not in returns which are unpredictable. As you can see in the code variable x is the time series of returns: x<-rnorm(100), but profit and loss (variable change) is calculated from return differences: change[i]<-x[i+1]-x[i] .

One of the commentators on the blog already provided the same explanation, I just hope this blog post provides more detailed explanation of this fascinating counterintuitive phenomenon.

Week in Volatility

There been a lot of action this week: we started off bearish, but overnight on Thursday reversed the course with a very bullish action. Week to week indexes remain almost unched, but what is clear that the markets are getting jittery.

Huge straddle trade in VXX

A huge straddle was crossed this morning in Jan-12 31 strike:
40000 calls at $7.46 and
40000 puts at $8.04.
The total straddle price was 15.5, which is almost at the mid-market at the time of the trade (straddle at 15.35 at 15.80) making it hard to tell if the trade was buyer or seller initiated. Either way, that is $62 million in juice!

ASX is getting serious about launching volatility futures and options

Back in September Australian Securities Exchange launched S&P/ASX 200 VIX, but recently ASX took a serious step towards launching derivatives on the index. ASX has released proposed contract specifications, and is soliciting feedback from the industry.

Here is the link to the paper.

The main points are:
1 Options will be American-style, exercisable against futures.
2 PM (close) settlement, as opposed to AM (open) in VIX.
3 Futures and options will have a multiplier of 1000 AUD

I think these differences from VIX and VSTOXX will hinder product liquidity, and my email will urge ASX to create a product that is more in line with the others. Email your comments to Brian Goodman, product development manager at ASX.

My previous post about ASX VIX here.

Update: S&P/ASX 200 VIX Index is now being updated in real-time, with plans to launch futures on "Australian VIX" in the second half of 2013