The action in the VIX last week was interesting. VIX spot finished the week a touch higher, even as the S&P 500 index climbed 1% on the week. Moreover, most of the important monthly U.S. macroeconomic data was released last week (PMI’s, payrolls), culminating in the non-farm payrolls release on Friday. Normally, if the market is quiet after the payrolls release, VIX spot will move significantly lower since the event risk is out of the way. Yet, VIX spot was only a touch lower by Friday’s close, and March VIX futures actually closed up around 3%.
Clearly, market participants are still wary about the potential risks to the market form geopolitical developments in Russia, as well as continued negative news flow out of China. Nonetheless, the divergence between the SPX and the VIX in the past couple months is noteworthy. VIX spot has not made a new low in almost a year, and made a new yearly high in early February:
In the meantime, the SPX continues to make new all-time highs.
Amidst this backdrop, VIX implied volatility has traced out higher highs and higher lows as well. We laid out that evidence in a CotD post on February 28th, with the following conclusion:
The increased implied volatility of the VIX is one more sign that the VIX trace out a higher range in 2014 vs. the past 2 years.
We still own the March 15/19 call spread vs. short the March 14 put in VIX (below), which we traded on February 21st for even money. March VIX expiry will be on the morning of Wednesday, March 18th. Part of the reason why we chose that structure on March expiry is that VIX spot is likely to remain elevated heading into the FOMC meeting on March 18th, so we would be quite surprised if VIX spot printed below 14 on the morning of the meeting.
Given that limited downside, we still like the risk/reward of holding on to the VIX position, especially given VIX spot’s resilience on Friday after the payrolls number. Also, the Crimea referendum is slated for Sunday, March 16th, which could be another headline risk for the market.
Our structure is currently worth about $0.70. Not a bad gain, but given what we still view as an asymmetric risk/reward situation, we like holding on for one more possible VIX spike over the next week. As we approach expiration the potential gains on spikes in vol increase, as the intra-day movements in the spot VIX and March futures start to coincide. With that in mind we’ll be looking for a big spike day to exit and or /roll.
New Trade – $VIX: Marching into the Next FOMC, February 21, 2014
With our most recent long VIX futures strategy now closed it’s time to look out to see if we can place this trade again. We like to isolate months with major economic or policy events because when these coincide with that month’s futures settlement we see an asymmetric risk reward on the VIX as it will tend to stay bid into that event. Thus, we only need one vol spike in the market between now and then to close the position.
With that in mind, given the string of weak macroeconomic data over the past month, the market is now laser-focused on the next FOMC meeting which is March 18th and 19th. While many are blaming the cold weather for the poor data, market participants are anticipating more dovishness from the FOMC after 2 weak jobs reports. The Citigroup Economic Surprise index for the U.S. is now negative for the first time in 3 months:
The weakening economic data has been ignored by the market given the expectation of Fed support. But if hawkish commentary from the Fed continues, as we’ve seen from many governors over the past couple weeks, even with the weak data, then another vol spike in the next month might be in the cards. The March VIX futures expiration once again coincides with the FOMC meeting.
Again, this strategy works well as an outright trade but works really well as a portfolio hedge as it takes some of the sting out of any selloffs in the market between now and expiration.
TRADE – Buy to open the VIX (14.40) March 14 – 15/19 call spread risk reversal for even money
– Sell to open 1 March 14 put at .55
– Buy to open 1 March 15 call for 1.00
– Sell to open 1 March 19 call at .45