Wednesday, April 26, 2017

Musing on Short Vix Verticals

Investing is never done or 'solved,' (although I think short VIX is getting pretty close), so I'm constantly musing on improvements and changes both to make strategical sense as well as help psychologically.
Tastytrade had an actual specific short VIX segment recently, suggesting straight VIX option verticals over naked.  They basically compared P/L and drawdown of short 50 delta/ 10 delta VIX calls, and 30 delta/ 10 delta VIX calls, with the % of time VIX is in each range and the P/L.

I even emailed back at them yelling that if you fully combine all the data across VIX segments (low, medium, high volatility), the strategy of buying the long option wing slightly underperforms.  This should be obvious, as that is the function of long options, but I was surprised they would  post this as a suggestion. 

I think was was missing a bit of the forest here, absolutely tunnel visioning on P/L, when the huge components of not only max draw down but buying power reduction were the main elements in play. 

Especially with a small account, the minimum size of a tranche or max loss is very important as that is what determines how fluid you can be with legging in and out of trades.  For example, with pure naked short puts, I was already at about my max cash allocation for low VIX going into this last 2 weeks which were very choppy.  With a smaller max loss per tranche, it is much easier to distribute capital and average down in all conditions.

 For example, lets say a naked short 130 SVXY call is going for ~4.50, tying up a 12550 max loss.
Adding a <5 delta long put on there, say the 80 put for a generous .50 (but probably less),  brings the max loss to 4600. 
For a monthly expiration, we could be going from 4.50 in premium risking 12550 to 8.00 in premium risking 9200.  

This brings me into total stock/option buying power, which is a function of the broker but also the overall strategy.  My core strategy using SVXY puts comes with the expectation of getting assigned, meaning we will be in a higher vol environment when things are going bad, so the other half or more of the account will be able to average down in a better pot odds scenario.  When doubling up the amount of notional contracts by lowering buying power required, this will probably end up dipping deeper into broker margin in extreme cases, but again, those will be the high yield high VIX market extremes.  

Margin is there for a reason, its allocated by the broker's risk management structure, so I'm starting to view that as using all parts of the buffalo.
Especially if you ever have the vision of managing other people's money or really turning this into a business, which I know a lot of options posters point to- If you aren't maxing out your current resources (current broker), will you suddenly be ready to switch up your leverage style later?  This permeates all business/life/goals- can I be doing more, optimizing?

One final musing on vertical spreads in general, kind of a recap of my journey-
When I first started options I watched from videos that "you always want to start with a vertical spread," it is risk defined and can be done with a small account.  Unfortunately I think viewing it as "above this strike- GOOD, below this strike- BAD" kind of stunted my options growth.  I wasn't really in tune with the full scope of your break evens as the strikes widened, the goal of short puts for assignment and then selling calls against stock, and overall account management.
When my account size got a little bigger to do naked SVXY short puts I was seeing the trajectory of decay on naked options, the fuller view on management possibilities- rolling, adding opposing short calls, etc. 
This was all great and now I'm looking further again, possibly full circle- The Hero's Journey-  Now combining all the strategies of naked puts, I'm looking to use the full buying power reduction of verticals again, combined with a better use of margin for more fluidity in legging entry.

Ok that's all the rambling for today..

Friday, April 21, 2017

Modern Monetary Theory and Big Red Numbers

This week I had an awakening.
I recently read an incredible piece, 7 Deadly Innocent Frauds of Monetary Policy, (free pdf) and while I don't agree with all the conclusions, it really simplified the structure of money flow involving central banks, which ties into my previous article about betting on the side of central banks.  I really recommend reading this (and this is coming from someone who can barely read).

The overall premise is that a country that has "debt" in its own currency can never go broke, as it just creates more money.  This "debit" on the Fed's balance sheet becomes a credit to the private sector- It's a zero sum game!  A debt-ceiling is just a private savings cap.
I frantically began scouring, going back to old interview and congressional hearing clips to hear it from their very mouths-
Greenspan to Paul Ryan
Another to congress
Bernanke 60 minutes

There is a lot more economics cooked into that, but my takeaway is for the individual investor, how can we apply that?  It dispelled some fears of mine about which have been repeated by Congress forever, "America is going to run out of money," "how are we going to pay for THAT," etc.  As long as the economy is running, there should always be a "debt" and deficit, that is just how much more money is working in the economy.

I think we are now just dealing with more of a semantic difference between "printing" and "creating" money, as well as the "debt" vs the "score keeper," where the Fed's balance sheet "debt" is just keeping score of the outstanding credit that people use in the economy.  (Again I can't stress enough to please read this pdf, a quick summary isn't that useful)

 So for short VIX, lets keep on rolling with the big guns backing us up.  The Fed's function is to create liquidity, which expands the economy.  The only non-psychological constraint on such printing is inflation/too much demand, which they've "reported" to be under target for a while.

Again, this is not to make a value judgement on the Fed.  My gut reaction sees it as a Bond villain organization.  This is simply to view the mechanical functions and incorporate those into our macro view and trading strategy. 

Now one more thing...

I'm trying to avoid too much trade journaling, but I've had an interesting few weeks with the recent backwardation action, and it does tie into this Fed debt business in terms of something looking worse than it is.
With the market humming along a few weeks ago I continued rolling my ~10% OTM SVXY short puts, which at the time was around the 130 strike.  I think I must have opened that position at the absolute top tick, around 11am -12 pacific, and in the next hour the market closed fairly red.

As of now I'm just between the breakeven and strike price, so conceptually everything is fine, but the daily P/L has had some very angry red numbers for me the last two weeks.

Regardless of volatility spiking up or slowly shrinking back down over the next few weeks, my takeaway is to remember the concepts.  I'm trying to visualize all of this in terms of intrinsic value only.  I pictured this like the Fed's huge balance sheet, where the "debt" is a very big angry red number that most people reference, but what does it really mean and what is the issue?  As long as demand and inflation aren't going crazy, this is just the net public savings working in the economy.
Similarly, even though my daily P/L on some puts looks ugly, I'm above the breakeven so the intrinsic value is there.  (And if assigned, then we just start selling calls against it)

One big step of the options and life journey is figuring out what really matters.  What big angry red numbers can we ignore and which do we pay attention to?  Which big red numbers do people misevaluate, and can we profit from that?

I'll check back in when all these positions go really bad, turn awry and lose the name of action!

Friday, April 14, 2017

How many layers deep are we?

With the market closed for good Friday I'm getting a little stir crazy, I NEED A GREEN TICK!  Here's a quick aside I contemplate when thinking about derivatives and how many layers we have, where we've come from and how much deeper we could go.
I also mention this when explaining the journey from stocks (which most people understand) to how we get to SVXY options. 

So here is the dive to the Challenger deep:

S&P Stocks- this is where we start, where everyone understands. Apple, Microsoft, etc.
S&P Options- the first layer of derivatives, based on the above stocks.
Spot VIX- the actual VIX index, based on the Black-Scholes calculation of 30 day S&P options (above)
VIX  Options- we can't trade the spot VIX, its just a number, so VIX options allow bets on the index and are cash settled.
VIX Futures-  the futures /VX and further out are based on the VIX options at the money price at the corresponding expiration.
VIX ETFs- These are trade-able products that act like stock, based on combinations of VIX futures, constantly being rebalanced between the first 2 months or further out depending on the product.  Here we have VXX, XIV, UVXY, SVXY, TVIX and more.
SVXY Options-  Of the VIX ETFs, just UVXY and SVXY have options so far, thus that is the main product I use, allowing access to time decay and varied leverage on short/long volatility.  At this point we are on the 7th layer down of derivatives, sunlight does not penetrate this far down.

How much deeper can we go? Obviously increased volume/liquidity would lead to options on all the ETFs, as well as new ETFs (VMIN, VMAX are slightly "more accurate" versions of VXX, XIV).

While I do revel in how arbitrary all of this is, I do have to remember that even at 7 layers down in derivatives, these all eventually lead back to S&P stocks, so I guess we still are in reality.  Thanks for joining me on the dive!

Wednesday, April 12, 2017

The Short VIX Macro Barometer: The Petrodollar and Beyond

 While stock/etf/options on every underlying trade fairly independently of any "fundamentals," each asset class has some real world metrics that correlate to it, at least in the sense of idiot analyst "reasons" for underlying movement.

Stocks- we have earnings, guidance, CEO tweets...
Bonds- Fed funds rate, corporate bonds
Oil- inventory reports, OPEC news
Metals- combination of mining plus movement in the above assets, policy

So what is the real world underlying concept for volatility as an asset class? I would argue confidence and status quo.  Now lets delve into this magnum opus...

If you aren't already familiar, please read up on the background of the petrodollar.  As a quick summary, in 1971 when the US went off the gold standard, world currencies became free floating, with the exception of an agreement for Saudi Arabia to only sell oil in US dollars in exchange for military support.  This effectively backed the US dollar with oil (previously gold) and gave it a pseudo commodity-currency status.  As long as the dollar has this oil backing, there will be a continued demand for it despite how much is printed out of thin air.

How does this affect short VIX or the individual investor?

My first takeaway here is that I don't want to sound like a gold bug, proving the system is a broken fraud(even though it is).  For many years I shook my fist at the sky, yelling at everyone who would listen about how the whole world economy is based on monopoly money and how it is all rigged.  I still hold all those beliefs dear to my heart, but the difference is that now, when combined with options and liquid markets, we can take any side of a trade.  This is the key step I think gold bugs and doomsday preppers have ignored.  If you see someone profiting from a rigged system, piggyback on that!

Okay okay, are we getting to short VIX yet?

What is the risk for short VIX? As volatility is mean reverting and contango will keep short VIX products going up after corrections, we only need to dodge a tail risk which destroys the modern economy as we know it.  In the mean time, we can experience 25, 50, 90% drawdowns, which we maximize by keeping a large cash position and riding the dollar cost average all the way back up, combined with options reducing our basis.
Lets go back to this undefined tail risk.  My view is that if we have a volatility event so dramatic, much worse than 2008 in the sense that the core of the world economy is called into question (the unlimited debt ceiling that mechanically can't be repaid), then I can't see the rest of the market continuing anyway.  Similarly, if you are only holding onto cash because you want to avoid an almost 100% correction and buy the dip, I'm afraid there won't be much left to buy, or those "dollars" wont be worth much.  I call this "there won't be any home to go back to"
I agree with the sentiment that there could be an absolute global meltdown based on how far from reality any monetary system is, the difference is that in the aftermath, dollars, gold, property won't have any value- probably only bullets a la Mad Max.

So for one of my core assumptions as a small investor- lets assume the system will continue, and in that system we have to trade, and beat holding cash.

Lets delve a little more into why the US dollar and reserve currency will continue, as that can definitely be a distinction from the previous apocalypse scenario.
It wouldn't take you long to find this one chart or 10 new charts that prove we are about to have a 50% correction, in fact I've linked FinViz news in the sidebar to see the daily ZeroHedge articles predicting the last 20 of 0 crashes.  This data isn't new, and has been brewing and stirring since before 2008.  Did every fund, trader, and "the powers that be" not notice this?  The only difference between a monopoly game where one player has sharply expanding debt which is structurally unsalvageable and the US is my original point: confidence
Without even mentioning motives, one does have to take a step back and at least in a vacuum have some kind of awe for what central bankers have done in terms of keeping the system afloat.  When confidence is the only thing backing a belief in money and value, there is an incredible space for creativity.  For example, in order to build confidence in money, you can:

1. Make the currency "stronger," improve GDP to debt, "productivity," have it backed by something, thus making people believe in it's strength


2. Alter people's beliefs, have them not care about it or be to stupid to do so, thus bypassing the "strength" of the currency entirely.  If there is an Instagram post to like, who cares about the deficit?  Its almost a cleaner and more elegant solution- brute force can knock down a door, but knowledge is a skeleton key.
To clarify- I'm not even mad or hating on Instagram idiots- a younger me was, but I think I've evolved. Every time you like a post or watch a show or eat fast food, you are contributing to the economy in a profound way that you might not even understand.  Do you hate on bugs for flying around and pollinating or worms composting soil with their excrement?
 If disbelief in fiat money is a virus, then confidence is the vaccine.  If you have only 1 person in a population that doesn't believe money has value, then everything will hum along perfectly.  They have no one to transmit with.  Once there are a few, they can interact with their own form of currency/trade/debt, and the 99+% run into a snag when dealing with these few.  Vaccines fail when a large chunk of the population is susceptible, and the few immunized don't stop the spread of the idea (disbelief).

Coming back to short VIX and the idea of a two sided market- who is supporting short volatility and who is long volatility?  I would argue these central banks and governments are short volatility- they are looking to stabilize risk, avoid massive spikes, and micromanage everything.  Who is long volatility? The gold bugs I mentioned screaming for the next overdo crash. 
 If you had to pick a side, which horse would you bet on?  I completely sympathize with everyone calling for the next crash, but when you look at them all together, they are a bunch of guys in front of green screens and hotel room interviews with their only resource being their yelling and BUY GOLD links.
In contrast, lets look at the "short volatility" guys, the ones banking on the status quo.  Central banks, the IMF, the US government, other governments and by extension most of the world military- basically the bad guys (except in real life the bad guys always win).  These are real assets and forces behind short volatility.  In contrast to the youtube and blog personalities talking about the petrodollar, the opposition are basically Bond villains with even greater resources. 
Not only do they have the resources, but they will use them and protect the petrodollar at any cost.  Any Middle East country wants to buy oil in Euros? We'll handle that.  Gaddafi wants to make his own gold-backed money to buy oil? Give him the smack down.

What if the petrodollar fails, what if oil ends?  How will they keep the charade going?

I really think oil or the "petro" part of petrodollar is just a placeholder, that can and will change.  For example, if the planet somehow shifts to all electricity, the only structure that needs to stay in place is that all energy transactions (oil, electricity, nuclear or more) happen in dollars, call it the electrodollar.  Ultimate that will be backed by another 1971 Saudi Arabia style deal,  complements of unquestioned military force.  When I was younger I also questioned why the US spends more on military than every other country combined.  Its all clear in the scope of the petrodollar.  As long as the US has the force to require that the world keeps running on dollars, that is the confidence they need- they only need that structure, then they can print their way out of other problems (corrections, market cycles, sector shifts).  Thus the petrodollar becomes the electrodollar and finally the gundollar, wardollar, nukedollar... what is the catchiest?

As I'm writing this I'm seeing Trump now supporting Yellen, all of our war and structure in the Middle East, and everything pro-petrodollar that he previously ran against.  Its almost like his boss picked up the phone and explained everything clearly.  As investors we have to look at actions and make conclusions.  If Trump was deflected by this Bond villain system, how could any future politician even make a dent?

To sum up-  

What world underlyings correspond to volatility?- confidence and the status quo

Are you tired of seeing a rigged system keep going? You can keep screaming or take the other side

Short volatility, the idea that fear will correct and go lower, is backed by the most powerful resources in the world.  When in doubt, why not bet on those guys?

Almost each of these paragraphs could have an entire separate article and I hope to get to them all.  I hope this wets your whistle as an introduction to the macro case for short volatility, in case you didn't even know what world events correlate to it.

Monday, April 10, 2017

VIX Backwardation Part 2: Uncharted Waters

 I'm beginning to think more and more that we really are in uncharted waters/Stranger Tides, at least for VIX.  We are in the 2nd week where VIX futures are in backwardation and its only getting steeper.  Some theoretical causation for this from Wallstreet Journal/ Zerohedge is a "feedback loop" from many big funds shorting volatility.
At the close when I'm writing this I'm looking at over 4% backwardation with the front month higher than May AND June.  Furthermore in looking at contango data back to 2004, the VIX futures were only in backwardation when spot VIX had a high of under 15 once on 3/8/2007, and the backwardation was -.29%

Looking back even recently to ~2011, we can see every backwardation event was accompanied by a high spot VIX >20, until now.

So what to do?

Personally, I've added short SVXY calls to my position, extending my downside breakevens and adding a little long vol to take advantage of the futures curve.  Going forward, if this structure holds, I think I'll lean towards SVXY strangles/adding short calls onto my existing short puts as the backwardation takes a lot of risk off of the upside.
I'll probably get assigned stock on the puts on some of these expirations, at which point I'll basically be in SVXY covered calls, keeping the long term short VIX assumption.

But does this make sense?

I'm still holding to the core belief that VIX has to return to contango, as the concept of free insurance just doesn't make sense.  However, at the same time I'm not rigidly holding to the belief that the market or any part of our modern era has to make sense.  Flat earth and geocentrism made perfect sense as well!  (Now mix flat earth with uncharted waters)

With volatility as an asset class, it got me thinking about the other asset classes that don't make sense-

Negative interest rates- If you explain the concept of savings to a small child, or even mildly lucid marsupials, they will point out immediately how little sense it makes to lock in a loss of capital.  Of course you can academically say there are reasons and structures for why interest rates will go negative, but the glaring conceptual problem on the surface remains.

Swap/Treasury rates- This is less of a retail/small investor trade, but looking at various articles on over-the-counter swaps trading lower than 'risk free' US Treasuries, we see another glaring issue- How would something with more risk than an identical product ever be worth less, how is there no floor?

Has VIX ascended into the now trinity of asset classes which make no conceptual sense?  I was trying to wait a little to start writing about this as who knows, it could correct tomorrow.  Even if it does, that doesn't change the fact that a new floor or ceiling has been breached for volatility, so I might as well yell anyway.

One upside to all of this is the unknown of the market holds, and surprises us in new ways each time.  At the first level of investing we think something is overvalued or undervalued and take the corresponding position.  We soon learn that something "overvalued" can keep going up, even to a $1 Trillion market cap.  For this reason I think you should throw fundamental analysis out the door if you haven't already.
Step two is to trade based on mechanics such as convergence/divergence, contracting volatility, etc.  Unsurprisingly even then, trading based on a mechanical fundamental such as "interest rates can't be negative" will eventually break down.  The upside of all of this is that any market (even one of ideas) can be two-sided, which theoretically means continuing liquidity.

I am still SHORT VIX! However- given the pricing of futures I think it makes sense to convert some short SVXY puts to strangles, adding some premium where there is a little less risk than there was previously.
And if none of that makes sense, in addition to the fact that its all probably wrong, instead just look at what the futures curve is telling you:

  Just do it!

Thursday, April 6, 2017

Low VIX Contango Thoughts

A few times over the last two weeks I noticed my trusty blade glowing blue, noting VIX had dipped into backwardation-
Tastytrade had a great discussion yesterday which pointed at some of the underlying macro VIX issues that you have to contemplate when having short VIX as a core position.  In summary, backwardation in VIX futures at such a low level has been almost unheard of and potentially reflects how much big money could be behind short VIX.  (Along with their trade idea of getting long VIX as without much contango you are getting long VIX without the roll cost which should be free money)

Is the small front month backwardation after the tiniest dip just a visual representation of buy the dip?  Conceptually the futures curve is pricing in a very short term vol contraction, which correlates with an equities rebound

 With this backwardation oddity I went off walking, rambling, thinking about futures curves in general.  Will the VIX curve always look the same?  As VIX products are traded more and more (and the equity options they are based on)  will these weird curve changes become more commonplace?

Would it make sense for a theoretical VIX futures curve to be a flat line at 15 or whatever the average is?  I keep coming back to the conviction that VIX futures have to keep in contango most of the time because there will always be uncertainty.  To lose the long term contango structure is saying  "the future is solved" and in finance terms there is no risk premium associated with thinking "some risk will occur in the future."

Will we see a much flatter front 2 months on the VIX curve when /VX is in the low teens?  I think this is definitely possible as more backtesting shows that periods of low VIX lead to more low VIX on average.

Going back to the actual trade ideas, the short term backwardation was a theoretical impetus to get long VIX with very little roll cost.  On paper that trade looks good but in the larger scope of assuming that the very backwardation implies a short term vol contraction, I think it is hoping for two opposite things at the same time.

Whether I end up wrong or right in the short term, the whole event was a time to contemplate conviction in your beliefs and process.  If I believe in the structure of VIX contango, then I have to be short VIX. (with risk management/ cash position)  Is this what religion or faith feels like? Is this the church of SVXY?

Monday, April 3, 2017

Life Probability of Touch

As I'm writing these we have a little action with S&Ps down 15 and the VIX contango at 0.0, and it even touched negative for a minute.
I went to get a screenshot on vixcentral and we were already back to slightly above 0 contango.

Am I happy, sad, crestfallen?  In short vix land, specifically with half reserved in cash for those big dips, we are always hoping for a real action day to kick it off.  When we get these slight down days its just a tease, not giving a real entry point but instead your account of short SVXY puts just showing really angry red numbers at you. (with no strikes even breached)

Last week or two we had a similar down day where I was getting careful possibly too early, selling calls against my position and then having to cover them on the quick rebound.
The options/life lesson here is really taking a step back when it comes to probability of touch.

Just after my little overtrade with the calls and stock, I had the classic work experience of waiting to hear from someone before some project/task needed to start.
(If someone emails back after some meeting, then we will need to finish something by the end of day, whatever- just fill in your own office hell here and flavor to taste)

One person could start preconfiguring things immediately and emailing around just to find out later that everyone else is an idiot and never responds, and it was all for nothing.
I'll give you the spoiler for my day- no one emailed back AS USUAL and a less seasoned version of myself would have had a lot of extra fluster.

So why am I getting nervous in the exact same trading equivalent situation?  In life and work with idiots I already have the conceptual probability of touch baked in, and in options where its about 2x your chance of expiring in the money, I'm guessing the work probability is actually higher.

It comes back to muscle memory and staying mechanical.  One of the takeaways I'm hoping to create in this blog (and mostly for myself) is to intuitively get better at crossing over life/poker/etc experiences into options trading to bring down the learning curve.  Here I already have a great intuitive life experience to know how to chill out and let the options positions and theta just do their own work instead of freak out at the first red tick.  Maybe next time I'll take a bigger breath.

Position sizing, bankroll management, stay mechanical, don't get hit by a bus.