Week of April 16 Volatility Review

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I read a funny head line over the weekend from a relatively well-known blog famous for getting "inside dirt" on Wall Street firms and for being super cynical. The title of the piece was, "Volatility is Back!" The writer explains that in four of the last five days, the market moved more than 1%. Apparently 1% to this author symbolizes a huge amount of market volatility. I think the author might have had much more credibility if he or she had written the piece with a title "Market Volatility is Ticking Up." It would have been much more inline with what is going on in the market. It's shocking how short trader's memories are.

Less than one year ago the market was in a total train wreck. Since the beginning of the year it has moved at an incredibly slow pace. There are snails and tortoises that move quicker than the S&P 500 did over the first third of the year. Now, over the last few weeks we are FINALLY starting to see the market move more than 1% a day with some regularity. But what does 1% a day really represent? It represents a volatility of right around 16%. Does anyone think that 16% is some sort of crazy level that will be impossible for market participants to keep up with? The short answer is no. Do worries exist, yes, of course, they do. Personally, I have been so off on my ability to figure out what is going on. I normally have a good feel for the overall direction of the market, that is gone. Thus, we have a VIX that is threatening 20%.

This brings us back to what we discussed. While I get a kick out of making fun of people that don't get volatility, I think the truth is the author was trying to put his or her head around what the market has been doing over the last week. We are in a transition period. The market is doing some sort of cycle. EU bonds, US economic reports, China, who knows? What I do know is that the market had a pretty clear direction for four months, and that direction is now gone.

Personally I don't think we see the other side of 1300, but I am not so certain that we are going to be booming back through 1400 on Monday as I thought on Thursday (goes to show how much the market is aimlessly meandering). One interesting stock to watch will be Apple (AAPL), which is threatening $600. If it breaks $600 and stays there watch out, it could be a quick trip to $550 before earnings as traders bail. We have a lot of earnings this week and next. Whether the market goes up or down might depend on earnings as much as it depends on anything else.

Looking at the vol products, I like our little CBOE Volatility Index (VIX) play; however I would put up a big stay away on iPath S&P 500 VIX Short Term Futures TM ETN (VXX), VelocityShares Daily Inverse VIX Short Term ETN (XIV) and many of the other products except for as directional plays. Roll yield and mean reversion does not make a lot of sense in the near-term. raders looking to trade volatility might want to look at the short-time spread. I think that IV has gotten high enough in June that one could warrant selling June and buying May. Right now, I think I want to be short implied volatility (vega) and long realized volatility (gamma).

This should be an interesting one.

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At the time of publication, Mark Sebastian held positions in VIX.