June 19, 2012
Contango is Back
The volatility futures curve is back in strong contango, and with it an opportunity to profit from the short trade on volatility linked ETFs/ETNs. For a primer on this trade, see previous articles here and here, but in short it’s an attempt to profit from the bias of investors to believe that market volatility in the future will be greater than it is in the present – essentially a fear of the “unknown unknowns”.
A Better Way to Play
In the past, I have advocated the use of short (VXX) or long (XIV) as ways to profit from steep contango, but there is, in my opinion, a more compelling way to profit from contango, short (TVIX).
is a 2x leveraged version of the VXX which should, in theory, return 2x the daily gains or losses of VXX or similarly structured funds.
However, as many have observed the TVIX had a pretty wild ride this spring. For those not familiar with the fund, in February the fund’s sponsor Credit Suisse temporarily halted creation of new units of the fund in response to skyrocketing demand and ballooning risk exposure for CS. Halting the issuance of new shares broke the mechanism that tends to keep funds trading in line with underlying value, and in a tulip mania moment, the market bid the price up to an 89% premium to fair value in just a few weeks. About a month later, when the sponsor resumed issuing shares on a limited basis, shares traded down sharply and more in line with fair value. More…
Everything went higher today (despite the data during the last minutes into the close); stocks, bonds and fear; a somewhat unique combination of ups. When noticing today’s relatively rare direct correlation between equity market volatility (aka VIX), equity indices and “safe haven” US government bonds, option market veteran David Robbins of WallachBeth Capital says, “The wall of worry is simply growing taller.”
With the benchmark barometers DJIA and SPX continuing to climb past technical and psychological barriers, and now only single digit percentage points away from all time market highs despite the still-fragile (albeit somewhat improving state of the US economy), “its always worth worrying” said Robbins, perhaps explaining the subliminal spikes noticed in outer-month VIX options, and in particular, put options.
Added Robbins, “The skew is always a good clue, and if you look at April and June VIX or VXX options, its clear that market pros are re-framing; the risk of a market pull back increases each week the equities market goes up. There’s always a black swan out there flapping its wings, but its simply more expensive today to hedge that risk than it was last week.
A snarly spike in iPath’s VXX is causing some to scratch heads..is it a sign of things to come (change in recent weather of sunny and warm)? Or, was the volume surge a symptom of traders sensing that one customer was liquidated by their clearing agent?
Read the full story courtesy of ETF Daily News More…