ftalphaville.ft.com, Izabella Kaminska

http://ftalphaville.ft.com/blog/2010/07/14/285751/is-something-really-scary-coming-in-october/

EmailDiggRedditLinkedInFacebookdeliciousMixxPropellerYahoo! BuzzstumbleupontwitterSharePrintIs something really scary coming in October?
Posted by Izabella Kaminska on Jul 14 11:38.

What on earth is going on with the Vix?

Dedicated Vix watchers at the Daily Options Report and Vix and More blogs are getting a little agitated.

It’s all down to the Vix futures contango, which has sharply steepened recently. More curiously still, it is running a particularly high premium for the month October.

As the DOR noted on Tuesday (emphasis ours):

October is roughly 3 month’s (and change) away, and the VIX futures are roughly $8 Nov even higher than that.

Pretty clearly Mr. Market expects a volatility pause this summer, followed by a return to Excitement this Fall. That’s normally a safe assumption as summer is the lowest vol. time of year.

What stands out now though are two things. One is the magnitude of the expected volatility pop. 3-4 points I could easily see. But 8 points? That’s some serious Fear.

But that’s not all. According to DOR the Vix itself is already running modestly high by trading at the 25.80 mark. For the market to expect it to hit the low 30s in October is therefore quite significant.

To compare, the index hit 56.32 back in October 2008.

Looking at the most recent futures curve, meanwhile, you can definitely see a pronounced bump around October:



But just to highlight the level of the steepening, here’s a chart from Vix and More of the historical difference between the VIX third month futures and front month futures going back about six months.

It really does shoot higher:



Although, with that in mind, we would like to add some more charts to the mix of our own. These in our opinion suggest there might be more to this October premium than just a simple fundamental volatitilty view.

First here’s a chart showing quite a significant build up in short interest in the VXX (the iShares Vix based ETN) from about February onwards:



And another showing the general volume explosion in the same period (against a mostly falling share price):



Curiously, there was an equal volume explosion in iPath’s mid-term ETN the VXZ (which sits further down the curve from the fourth (October) month onwards) around the same period — although with a significantly larger price gain:



And lastly Barclays’ own data regarding AUM and liquidity regarding the two funds (found in an SEC filing, rather than on the ETN’s actual home page):



We can’t think the last time all those trends came together in an exchange traded product and underlying future.

Oh, apart from the time both the USO and UNG exchange-traded commodity funds saw assets under management spike, short interest surge and contango in the underlying jump — all against a largely static or falling price.

As for NAV/price deviations… Here’s the VXX deviation getting larger of late (courtesy of Morningstar):



And one last curiosity: why would the short-term VIX ETF (VXX) see no price anomaly during May 6 ‘flash crash’ day (first chart) but the VXZ see quite a substantial one (second chart)?





Answers on a postcard to FT Alphaville please (or in comments below).

Although, our hunch is that the VXX and VXZ are the latest funds to attract some sort of high frequency based contango-spread arbitrage trade.

Related links:
A GLD contango strategy – FT Alphaville
The problem with commodity ETFs – FT Alphaville
A self propelled pyramid? -FT Alphaville
How contango affects oil ETFs – FT Alphaville

This entry was posted by Izabella Kaminska on Wednesday, July 14th, 2010 at 11:38 and is filed under Capital markets, Commodities. Tagged with exchange traded notes, vix, volatility, VXX. Edit this entry.

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1.Report Charles Surface | July 19 9:37am | Permalink
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Andrew Purdy - hahaha, no seriously, stop it. 2.Report admin | July 16 2:39pm | Permalink
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The Swap Vigilantes are going to create a crisis in the municipal bond market and force the politicians to take a difficult muni bailout vote right in front of the November elections. That's my guess. 3.Report Andrew Purdy | July 16 3:31am | Permalink
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Maybe they are betting on The Great Obama's "October Suprise" for the midterm elections. He has to do something to retain his Congressional majority, if he doesn't want his administration ripped apart by subpoenas and investigations. So what can Barack The Magnificent do? There is one thing. He can "wag the dog" by starting a nuclear war with Iran, North Korea, or both. 4.Report rjacobs394 | July 16 3:14am | Permalink
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China is slowing adn it should manifest itself in October. 3rd qtr earnings will not be robust. The media will begin to report US debt ceiling will be reached and it will need to be increased. $2T win US debt needs to be refinanced. The only thing that can save us is if the Yankees win the World Series. 5.Report TheBroker | July 15 8:49am | Permalink
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Lady Economist,

Any chance you can get me 2l of vodka and 400 Marlboro please?

Love

Broker 6.Report Daniel Kruppa | July 15 3:53am | Permalink
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I rekon early October is about the perfect time for a geopolitical crisis. November congressional elections, g20 november meeting, Nato summit meeting in december etc... 7.Report Austrian Banker | July 14 10:46pm | Permalink
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Taleb gone out shopping again. 8.Report Lady Economist | July 14 5:20pm | Permalink
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if you acutely look there is a lot of leverage on Leverage on there. 9.Report shotHotBot | July 14 4:20pm | Permalink
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I would also say that I don't see anything super special about October just looking at the futures. If you do UXA CTG on you bbg October doesn't really stand out to me, YMMV. 10.Report OJatHome | July 14 4:00pm | Permalink
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well there'sthe
risky risk
riskless risk
riskless riskfree
risky risk free

i know where i want to be 11.Report TheWord | July 14 4:00pm | Permalink
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Izzy,

There are so many spread/contango/correlation/swap/CDS trades going on at the moment that it is an accident just waiting to happen. However, barring an accident, it normally takes something fundamental to blow it all up. 2008, for example, was not caused by Lehman, but by the US housing bubble deflation which squeezed and squeezed Lehman's liquidity via margin calls and rapidly declining collateral quality, until one weekend it just went, "Pop!"

So, the question is: if the smart money is betting on October, what is starting to be squeezed, ever harder at the moment, which might reach its tipping point by that month? 12.Report shotHotBot | July 14 3:56pm | Permalink
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Very interesting!

I havent had time to do all the maths, but recall that a futures market has a risk premium interpretation as well as an expectations interpretation. The crude oil or Eurodollar futures certainly do, in any case. The market may simply be concerned that risk aversion (as measured by the vix) is could rise in the future and is willing to pay up for insurance.

So the risk of risk is getting riskier. (No arguing with that kind of logic, is there). 13.Report Lady Economist | July 14 3:28pm | Permalink
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Hi Izabella

Having great time,Weathers nice,betting that market will go in to melt down by October watch for couple of banks and hedge funds

,Because china will stop buying commodities any derivative decisions made by the ETFs would betting be upward.market going down wards Also massive selling and panic.Liquidity will dry up and there will not be able to make any calls to settle on the ETFs,

Love

Lady E

Ps Need any duty free make up,Faggs,Boose let me no 14.Report StevenL | July 14 3:16pm | Permalink
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Oh and I've given up with stop losses on non levered holdings. I did a lot of thinking under my tin foil hat the other night and decided that these banksters can not only see them with their lizard eyes, but have have devised some kind of cunning way to turn them against you! 15.Report Izabella Kaminska, FT | July 14 3:05pm | Permalink
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http://www.marketf...capital-shows.html 16.Report Izabella Kaminska, FT | July 14 3:05pm | Permalink
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Interesting that Harbinger acquired a very big position in VXX in May. They're now the second biggest owner of the ETN. 17.Report StevenL | July 14 2:45pm | Permalink
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So how does the average schmuck like me trade "some sort of high frequency spread-contango trade" then?

Do I just wait for something silly to happen in the Autumn then trade the correction? 18.Report jacobthemonster | July 14 2:19pm | Permalink
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VXX and VXZ options started trading in late May, so I think that explains the big build up in VXX/VXZ short interest and volume around that time.

The different reactions to the "Flash Crash" likely just comes down to liquidity. 1.3M VXZ shares traded hands that day vs. 50M+ for VXX; bid/ask spreads likely just got blown out when there weren't enough shares around to feed demand. 19.Report Izabella Kaminska, FT | July 14 12:59pm | Permalink
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Actually I'm of the opinion that there's some sort of high frequency spread-contango trade going on here -- October fundamentals only a side issue. 20.Report TheWord | July 14 12:52pm | Permalink
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Great analysis, Izzy. We have weakening final consumption, weakening private sector strength, devastating shortening of duration in debt maturities in banks and sovereigns, exponential increases in sovereign financing requirements, ZIRP in major markets, leading to a crowding-out of all but the best credit risks.

This will all (must) come to a crisis at some point. Whether it's October, or not, it WILL happen. The only question is whether the money-printers will start early, or late. They seem to still be on their summer holidays, at the moment. 21.Report Nijinsky | July 14 12:28pm | Permalink
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something scary in October...yes Halloween 22.Report swissfrank | July 14 12:26pm | Permalink
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I'd had October down in my diary as the moment when Q3 corporate results would show up poor consumer demand (and the end of inventory rebuild and easy comparatives) AND the moment when Bernanke stimulus would ease. In short, the pig without the lipstick.

I now wonder if I'm not 6 months too early. The US mid-terms, UK business conditions in early 2011 can only add fat to the fire. So October seems early although it is a good season for crashes.