With the holiday season in full swing, the VIX move back into the low teens is not a major surprise. Traders anticipate another week of quiet before the start of 2015 on Friday, Jan. 2nd.
However, trading patterns in U.S. equity markets in the 4th quarter of 2014 have been anything but quiet recently and particularly unusual compared to much of the price action of the past 3 years. First off, while the S&P 500 index made another new all-time high last week, the path of index prices has been anything but steady. Volatility has picked up on both the upside and the downside, with the recent selloffs more severe, and the recent bounces also much more rapid.
60 day realized volatility in the S&P 500 hit its highest level of the past 2 years:
That’s particularly surprising considering that December is normally a low volatility month on a seasonal basis. Moreover, while 30 day implied volatility in the SPX has fallen back to 12, even recent 10 day realized volatility (which includes this holiday week) is still in the high teens:
As we approach the start of 2015, the increase in volatility in December looks more likely to continue rather than subside. Aside from the ongoing concerns about oil, Russia, the stronger dollar impact on emerging markets, and the Fed, consider the following potential new catalysts to move markets over the next month:
– Possible Greek parliamentary elections (with anti-Europe party Syriza leading the polls) if the Dec. 29th vote to confirm the Greek presidential candidate fails
– Earnings season in January. This also implies a cutback in buyback demand for stocks as corporates cannot run buyback programs during the quiet period around earnings reports (a possible factor in the mid-October volatility).
– The next ECB meeting on Jan. 22nd, with the fate of QE in the Eurozone still uncertain
– The start of a new year, which takes many fund manager scorecards back to 0
With all of that in mind, in addition to the overall increase in SPX realized volatility, the quiet holiday period could be a good time to initiate a new VIX long position while traders discount the possibility of volatility in the very near future. We’re not initiating this today but will look to do something similar on or before the 31st. VIX spot has declined for 6 straight sessions heading into today. A somewhat more aggressive structure than our normal looks interesting in Feb expiration, but we’d love to see one last Feb VIX implosion and maybe move the short put strike down 1 dollar. So here’s the interesting structure as of today:
HYPOTHETICAL TRADE – Sell the VIX (14.48) Feb 15 put and buy the Feb 18/25 call spread for even money
– Sell 1 Feb 15 put at 1.05
– Buy 1 Feb 18 call for 1.85
– Sell 1 Feb 25 call at .80
Break-Even on Feb Expiration:
-Profits up to 7 between 18 and 25, max profit of 7 at 18 or above
-Losses below 15 in a linear fashion
Selling the 15 put in Feb VIX introduces higher risk than many of our prior VIX trade structures of the past year (when we normally sold the 14 or 13 put), but realized volatility is also near a two year high in the S&P 500 index, indicating a higher volatility backdrop overall. In addition, given that VIX spot is only at 14 in the middle of the holiday season, we would be surprised to see VIX spot spend much time below that level once the new year begins. On the upside, this trade offers a decent potential reward for the risk taken, with profits all the way to 25 in the VIX. But we still have a few days before year end and it would be a shame to enter this trade today and then see Feb futures even lower on Monday or Tuesday. So we’ll re-visit this early next week and see if we can get an even better entry.