April 3, 2017, 4:00pm EST                                                                 Invest Alongside Billionaires For $297/Qtr

As we discussed last week, we should expect more volatility in markets in the coming months, with the continued discovery surrounding Trump Policies (timing, size) and with UK/EU Brexit negotiations officially opening. That’s a dose of unknowns which should send stocks swinging around quite a bit more than we’ve seen for the past four months.

Remember, on Friday I noted the message the bond market was sending — with market interest rates (U.S. 10 year yields) closing the week, and quarter, at 2.39%.  That’s almost a quarter point lower than the high that followed the March rate hike (the third in the Fed’s “normalization” process).  And it’s about 10 basis point lower than where the 10 year stood going into the December 2015 rate hike.  That’s a negative signal.  And I suspect stocks will get that message.

With that said, the first day of the second quarter opened today with a slide in stocks, a slide further in yields and a rise in the price of gold.

When stocks go down, people get nervous and buy downside protection.  That tends to spike implied volatility.  There’s an index that measures that called the VIX.

Let’s talk about the VIX…

The VIX measures the implied volatility of options on the S&P 500. This is a key component in the price investors pay for downside protection on their portfolios.

So what is implied volatility?  Implied volatility measures both actual volatilityand the options market maker community’s expectations (or perception of certainty) about future volatility.  When market makers feel confident about the stability in markets, implied vol is lower, which makes the price of options cheaper.  When they aren’t confident in stability, implied vol goes up, which makes the price of an option go up.  To compensate those that are taking the other side of your trade, for the lack of predictability, you pay a premium.

You can see in the chart below, vol is very, very low — but has been ticking up.

Still, it takes a significant event – a high dose of uncertainty – to create a spike in implied volatility.

That spike tends to correlate well with a sharp slide in stocks.  Otherwise, we’re looking at a garden-variety correction in stocks — and that’s what this low vol environment is spelling out.

January 30, 2017, 4:00pm EST                                                Invest Alongside Billionaires For $297/Qtr

The Trump agenda continues to dominate the market focus as we entered the second week of Trumponomics.

To this point the market focus has been on the pro-growth agenda.  With that, stocks have been higher, yields have been higher, the dollar has been higher, and global commodities have been broadly rising. Meanwhile, gold (the fear trade) has been falling and the VIX has been falling, toward ultra-low levels.  The VIX, like gold, is a good market indicator of uncertainty and/or fear.

Let’s talk about the VIX…

The VIX measures the implied volatility of options on the S&P 500. This is a key component in the price investors pay for downside protection on their portfolios.

So what is implied volatility?  Implied volatility measures both actual volatility and the options market maker community’s expectations (or perception of certainty) about future volatility.  When market makers feel confident about the stability in markets, implied vol is lower, which makes the price of options cheaper.  When they aren’t confident in stability, implied vol goes up, which makes the price of an option go up.  To compensate those that are taking the other side of your trade, for the lack of predictability, you pay a premium.

With that in mind, on Friday, the VIX traded to the lowest levels since the days before the failure of Lehman Brothers. That indicates that the market had (or has) become a believer that pro-growth policies, combined with ultra-easy central bank policies have created a buffer against the downside in stocks.  But that perception of downside risk is changing today, with the more vocal uprising against Trump social policies.  You can see the spike (in the far right of the chart) today…

So as big money managers were closing the week last Friday, looking at Dow 20,000+ and a VIX sliding toward levels not too far from pre-crisis levels, buying downside protection was dirt cheap. This morning, they’re paying quite a bit more for that protection.

With that said, this pop in the VIX and the Dow trading off by more than 100 points today gets a lot of attention.  But is there justification to think that market turbulence will begin to reflect the turbulence and division in public opinion toward Trump policies?  Just gauging the extent of the market reaction from the VIX today, it’s unlikely.  The chart below is the longer term view of the VIX.

My observations: The VIX has had a small bounce from very, very low levels.  On an absolute basis, vol is still very cheap.  When there is real fear in the air, real uncertainty about the future, you can see from the spikes in the longer term chart above, the premium for the unknown gets priced in quickly and aggressively.  Given that there has been virtually no risk premium priced into the market for any falter in the Trump Presidency, or the execution of Trump policies, the moves today have been very modest. And gold (as I write) is barely changed on the day.

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September 15, 2016, 6:00pm EST

Since Friday of last week, there have been a lot of reports on the spike in the VIX.  Today I want to talk about the VIX and the performance of major benchmark markets over the past week.

In a world where stability is king, central bankers have been very sensitive to swings in key financial markets, with the idea that confidence and the perception of stability can quickly become unhinged by market moves. When that happens, it becomes a big, viable threat to the global economic recovery and outlook.  It can certainly send policy intentions off of the rails (as we’ve seen happen time and time again with the Fed).

Should they be worried?

With the above said, some might think the biggest threat to a Fed move in September (or December) isn’t economic data, but this chart.

Sources: Reuters, Forbes Billionaire’s Portfolio

First, what is the VIX?  The VIX is an index that tracks the implied volatility of the S&P 500 index.  What is implied volatility?  It’s not actual volatility as might be measured by the dispersion of data from is mean.

Implied vol has more to do with the level of certainty that market makers have or don’t have about the future.  When big money managers come calling for an option to hedge against potential downside in stocks, a market maker on the floor in Chicago at the CME prices the option with some objective inputs.  And the variable input is implied volatility.  When uncertainty is rising, the implied volatility value includes some premium over actual volatility.  In short, if you’re a market maker and you think there is rising risk for a (as an example) a sharp decline in stocks, you will charge the buyer of that protection more, just as an insurance company would charge a client more for a homeowners policy in an area more included to see hurricanes.

So with that in mind, the implied vol market for the S&P 500 had been very subdued for the past 45 days or so, quickly falling back to complacency levels following the Brexit fears of late June.  But since Friday, when market interest rates on government bonds spiked sharply (in the U.S., German, Japan), the VIX spiked from 12 to 20 (a more than 60% move).

That indicates a couple of things: 1) Stock investors were spooked by the move in rates and immediately looked for some downside protection, and 2) market makers aren’t quite as complacent as they appeared when the VIX was muddling along at low levels.  They are quick to raise the insurance premium, highly spooked by the risk of a sharp decline in stocks.

But it looks like this recent spike might have more to do with market maker community that is psychologically damaged by the abrupt market moves of the past eight years.  Gold is down since Friday – giving the opposite message of what the VIX is giving us about perceived uncertainty (people smell fear, they buy gold).  And the S&P 500 has only lost 1.3% from its peak last Friday.

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