Week of March 4 Volatility Review
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Do I think this means the market is going to crash? Probably not. Despite the rally in VIX and the bad news out of Italy on Monday, the major indices ended UP on the week and got within a hair of breaking all-time Dow levels. I think the buying of premium probably stems from fear of European headlines, and people are actually hedging as we hit this top.
Another interesting thing I am noticing is the 'vol of vol.' While VIX has stayed low, its swings from 13 up to 19 and then back to 15 which has caused a major spike in the volatility of the index. Over the last 10 days, the HV of the VIX has been close to 220% on an annualized basis. This means that VVIX, which is the volatility of VIX options, trading at 88% is probably too cheap. Yes, the futures do not move as much as the cash, but their vol has been above 100%.
Let's look at changes in actual movement. Go to VOLX.US and look at a number called RVOV, which is the 21-day HV of HV (on a daily basis how much has 21-day historical volatility been changing). The RVOV itself is actually close to 200%.
So what does all this mean to us traders? As Jared stated, it is SO tempting to sell premium on these spikes, things like VIX futures, VIX calls, long puts or VXX. This is not necessarily the best move. IV indexes seem to be fairly priced relative to market movement. I don't think a heavy long OR short actually makes sense right now.
The key may be to look at the IV of IV for answers. Those that have the time to be actively trading, we can do something similar in options by day trading the vega of the options. Basically, we can buy straddles when vol sells off, and then sell them back on these pops. Because IV is swinging around so much we may be in out of positions several times a day. This is very similar to what options traders have been doing in Apple (AAPL) for several months. Vol day trading is not easy and one has to have a firm understanding of how to trade Vega, but that may be the trade that has the most edge.
In an environment where swapping vols back and forth is a good idea, being consistently long or short vega is not a great idea. Until I get a feel for how IV is going to move (my guess is it will settle back down), I am going to be trading much flatter than normal and only executing specific VIX trades that have the limited risk.
Have a good trading week.
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Mark can be followed on Twitter at twitter.com/OptionPit
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