Tagged: VIX

Behavioral Volatility

I recall knowing one particularly volatile fellow. I should have called him VIX.

Speaking of the VIX, options on that popularly titled Fear Gauge expire today as a raft of S&P components report results. Many will see sharp moves in share-prices and attempt to put them in rational context.

Volatility derivatives are no sideshow but a mainstream fact. Yesterday the top five  most active ETFs included the SPDR S&P 500 ETF (SPY) a Standard & Poor’s Depositary Receipt from State Street that traded 68 million shares, more than any single stock including Apple ahead of results, and the VIX Short-Term Futures ETN iPath (VXX), with 38 million shares, matching Facebook’s volume (out-trading all but seven stocks).

Louis Navellier turned the concept of volatility into quantitative analytics for investment at his Reno advisory firm managing $2.5 billion. Oversimplifying, rising volatility signals change. Mr. Navellier used increasing volatility as a signal to sell highs and buy lows.

By the same token, when your shares break through moving averages, it’s at root a volatility signal. Your price is changing more than the historical central tendency.  But what causes volatility?

This is why we introduced Market Structure Alerts in June for our clients. They’re predicated on the seminal principle that volatility signals change. Rising standard deviation is a pennant pointing to developments you should know. But we want more than surface answers.  Measuring tides alone offers no reasons. So we measure behavioral volatility, not price or volume volatility – which is a byproduct of the former.

When the ocean rolls or roars, we understand that it reflects something else ranging from the gravitational pull of the earth and the moon to earthquakes undersea. We use these facts to shape our understanding of how our ecosystem called earth functions.

A conversation I have often with IR professionals is what I’ll call Story versus Structure.  “My CEO wants to understand why we’re underperforming our peers.”  We have a simple answer and an elementary model that demonstrates it. Yet it can be hard to let go of the notion that underperformance traces to a fundamental feature, the Story. “Our return on equity trails our peer group, so that’s got to be the reason.”

Now sometimes Story is the problem. When it is, it manifests in behavioral change. But don’t forget that the biggest investors are Blackrock and Vanguard. We’re told they’re perpetual holders. No, they’re perpetual trackers of benchmarks like the S&P 500 so they are perpetually in motion, relentlessly sloshing like tides. When these tides crash more violently it’s because money in 401ks and pensions is uniformly beginning to buy or sell, producing disparate impact in stocks.

It’s not Story but Structure. The market functions in a defined way, according to a set of measurable mathematical rules, just like the universe. If we omit some part of market function because it’s complicated it doesn’t cause the behavior to cease to exist. Every IR program today should measure behavioral change.

How many ETFs own your shares?  Our smallest client with market cap of $200 million is in 14. Most are in 30, 40 or more, some over 100. Each of these probably has options and futures and tracks an underlying index, which also has options and futures. All the components of each ETF and underlying index likely have options and futures, just as your shares might. There are exchange-traded notes that directionally leverage indexes and ETFs. Swaps that substitute returns in baskets of these for proceeds in other asset classes. Traders pair futures with stocks and change them each day. And throughout, Blackrock and Vanguard and the rest of their asset-allocation kin behind two million global index products move like massive elephants ever crossing the Serengeti.

Sound dizzying?  It’s your ecosystem. The good news is we’ve reduced its complexities to a set of central tendencies and now we have Alerts that signal when these change.

Why should you care in the IR chair? We’ve got a friend who’s a realtor in Steamboat Springs. She knows everything about it, down to the details of any house you can mention that’s on the market. She knows which neighborhoods get sun in the afternoon, where you should be for easy access to amenities. She knows her market.

We want you to know yours. We hope to help you move from seeing price and volume as a tide moved by mysterious forces to understanding your ecosystem and what distinct behavioral change is behind volatility.

That in turn makes you a powerful expert for your Board and management team. You don’t have to do it, of course. But the quest to be better, to know what there is to know about the market you serve is the difference between something that can become mundane and an enterprise ever fresh and new, an exhilarating exploration.  Some volatility, so to speak, is refreshing!

Correlation

“Why is our stock underperforming the peer group?”

Ever got that question from your CFO or CEO?

We hear it too. Speaking of questions, if you’re in Atlanta come throw them at the panel on High Frequency Trading for NIRI’s chapter breakfast, Friday Nov 16 at Maggiano’s in Buckhead. I’ll be there, and even better, so will the Nasdaq’s Jay Heller and the NYSE’s Rich Barry. We believe our story will rival this David Petraeus thing.

Just kidding. Back to the start, the answer most times lies in fine shades of difference. If program trading for funds and models in your stock is just 1% lower than the average in your peer group, spread over a month you might trail it by 10%.

The good news for IR folks, it’s not because you’re falling down on the job. It’s just math – which you might shake by targeting potential holders with shorter horizons and more aggressive trading proclivities.

Left unattended, these patterns tend to intensify. Mathematical models, identifying discrepancy, reweight allocations and the pattern reverses. It then repeats in shrinking cycles until something rattles the whole market and things reset.

Speaking of resets, high correlation, or uniform trading patterns, is a harbinger of looming group stampedes. Now, don’t worry. We don’t hear a thundering herd. We just see curious and repeating correlations.

Correlation in US stocks hit a record 88% in 1987 during the market crash. Before it happened, correlation soared to 81%, about the same level we saw in 2008 when Lehman left for the big brokerage in the sky and markets went the other direction. (more…)

The Epic Divide

Thrilling. Arduous. Rewarding. Draining. Spectacular.

No, not the Federal Reserve Open Market Committee meeting concluding today with a soliloquy before public microphones from the chairman.

We mean our grand cycling adventure riding the Rockies on the high backbone of the fruited plain last week. After 1,500 training miles we clocked several hundred more and about 25,000 vertical feet climbing a collection of the globe’s great mountain passes. The desire accomplished is sweet to the soul (one of my favorite sayings because it reflects the human spirit). Here are Independence Pass, the rim of the Black Canyon of the Gunnison, atop Ute Pass northwest of Silverthorne, and aspens outside Aspen.

Speaking of epic, NIRI this year again reminded me about the divide between how markets work now and – take no offense, it’s just a refrain from IR pros – what most of us know about them.

Here’s a current example. Why were prices and markets swinging wildly Tuesday, with disparity between major measures and extreme moves in stocks? Rational investment? Most of us intuitively know investors aren’t responsible.

What is? Fluctuating currencies, yes (hour-by-hour now). But did you know that VIX futures expire today? Last Thursday and Friday, other options and futures expired, and S&P indexes rebalanced.

Behaviorally, expirations are seismic (we study trading behaviors at a mathematical level) because trading is global, 24-hour, and multi-asset-class. When an instrument like a futures contract expires, there’s a ripple effect. (more…)

Predictable Outcomes

It was 85 degrees Sunday in Denver when Karen and I rode up local landmark Lookout Mountain on bikes to pay respects at Buffalo Bill’s grave. We woke to snow Tuesday.

Speaking of hot and cold, we told clients to expect a good start Monday for the new quarter, followed by the strong likelihood of a big move Tuesday or Wednesday as imbalances from the quarter exited broker-dealers. The Dow was down more than 100 points intraday Tuesday.

Why are these outcomes predictable?

In answer, ever heard of Mexican film maker Alejandro Gonzalez Inarritu and writer Guillermo Arriaga? The duo sadly parted ways after making Babel (Brad Pitt, Cate Blanchett), the third film following Amores Perros (Benicio del Toro) and 21 Grams (Naomi Watts, Sean Penn) with disparate threads woven into haunting themes on life and meaning.

Markets have recently given us disparate threads that can be loomed into predictive thematic raiment. Rumblings continue about the dramatic BATS Exchange IPO debacle March 23. The market-structure bugs at Zero Hedge advanced a theory that a deliberate algorithmic tactic torpedoed the IPO. (more…)

Clouds and Wind Without Rain

We’re in glorious Cincinnati where the land is rushing headlong into spring. Even a photo snapped in haste northward at night from Covington at the John Roebling Bridge seems cast in ethereal light.

Speaking of rushing headlong, if you’re here in the heartland, join us at the noon NIRI Tri-State chapter meeting today. We’ll talk about what’s got markets hasting.

There’s a saying from the bible: “Like clouds and wind without rain is a man who boasts of a gift he does not give.”

It made me think of volume. Enough of you have written asking about what may underlie declines in market volume that it deserves a community answer. We hope ours will do.

In 1980, Wilshire Associates was tracking about 3,500 publicly traded companies in its index that would become the Wilshire 5000, the category-leading total-market index. The Dow Jones Industrial Average closed that year at 963. Average daily trading volume was 45 million shares on the NYSE.

By 1990, the Wilshire 5000 had over 5,000 companies as IPOs outpaced consolidation. Average daily volume across the NYSE, Nasdaq and American Stock Exchange was 302 million shares, and the Dow Jones Index closed at 2,633.

In 2000, total companies had slipped from the 1998 zenith of 7,460. But daily volume had mushroomed to 2.8 billion shares. The Dow concluded Y2K at 10,786.

Volume built to helium-laughter level of about 7 billion shares daily in 2009. But in 2012 so far, markets are averaging 3.6 billion shares daily. The Dow is up. But the number of public companies is down. Way down. Care to guess how many make up the Wilshire 5000 in 2012? (more…)

VZZB Is a Sign of the Times

Your shares compete for attention with a dizzying array of choices in securities markets. Money chases what the market gives today. VZZB is the sort of example you can’t make up.

It’s the trading symbol for the iPath Long Enhanced S&P 500 VIX Mid-Term Futures ETN. We saw the circular from Direct Edge, where it began trading today. It’s not some cheese ball confection lofted by off-shore subsidiaries of Boca Raton broker-dealers. It was created by Standard & Poor’s. It’s underwritten by Barclays.

VZZB is an exchange-traded note (ETN), an uncollateralized debt obligation backed by Barclays that trades like a stock, leverages returns, depends on volatility and consists of futures contracts that mimic the supposed future volatility of an index. For gains.

Why should you care, sitting there in the IR chair? Eight of ten days, your stock is moving because somebodies speculated on the divergence of this versus that, or some other bodies tweaked their risk-management schemes to offset increasing implied volatility. Or whatever. It’s all interrelated. If you want to know why your stock behaves the way it does, you must see it in context of how markets work and what behaviors drive supply or demand in your shares. (more…)

Maybe we should leave more often. Out just one week, and both silver and Osama Bin Laden’s house go on the auction block.

Sunday night after flying back from Antigua by way of Newark, I reviewed a week’s worth of client stock alerts for perspective. Stepping through a side exit and closing the door on life’s cacophony for a week, time stops. The return, the jolt of the madding crowd, is revealing. It’s amazing what you see.

More in a moment, but I promised some of you I’d share what we saw beyond the Truman Show. Apparently you can’t get from Denver to the French West Indies in a day on one airline, (more…)

Volatility and Small Caps

We’ll spend the bulk of today’s note explaining why small-cap stocks increasingly find their shareholdings dominated by a few large quantitative institutions.

First this on equity markets: Last week we noticed a surge in “volatility trading.” We’ve written before about these tactics that capitalize on volatility as the asset instead of the direction of the markets or a given security.

(more…)