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How Low Can the VIX Go?
What's going on with market volatility? You'd think with Standard and Poor's putting the US government on notice that it risks losing its AAA credit rating and Greece teetering on the abyss, markets would be going haywire waiting for the next shoe to drop.
David Berman of the Globe and Mail asks, Why did stock market panic?:
Here’s
yet another theory why U.S. government bonds are failing to react much
to the Standard & Poor’s cut to the U.S. credit rating outlook:
The bond market had already priced it in.
From Jan Hatzius at
Goldman Sachs: “Clearly, the U.S. fiscal situation is unsustainable
unless a large, multi-year fiscal tightening is implemented. However,
there is no information in today’s report about the fiscal situation
that was not already known. Academic research has generally found that rating agency actions lag market pricing, rather than lead it.” [Double SIGH!!]
This sounds reasonable, though it raises the question why the stock
market was so quick to panic. The Dow Jones industrial average was down
nearly 250 points at its low point during the day. Even though the Dow
recovered about 100 points in afternoon trading, the stock market
nonetheless stood out for its hysterical reaction to the S&P report.
The CBOE volatility index,
or VIX – which is considered a fear gauge of the market – had jumped in
early trading. But the gains were still slight: The index hit an
intraday high of 19 before settling back to 17 in the afternoon, which
is exceptionally low.
Last spring, during the stock
market correction that followed the European debt crisis, the VIX had
shot above 40. And during the initial reports of the Japanese
earthquake and tsunami in mid-March, it rose close to 30. By
comparison, Monday’s blip looks like nothing.
True, after surging as much as 23% Monday, the VIX dropped 7% closing at 15.83 on Tuesday, just above the 15.32 close of last Friday, its lowest finish since July 2007. So what's going on? Why are markets so complacent? Isn't the world coming to an end?
Perhaps the VIX isn't the right gauge of fear. At Zero Hedge, Tyler Durden posted a comment late Monday afternoon that the SKEW does not paint a remotely as rosy picture as does the VIX.
Moreover, Tyler noted that the Credit Suisse Fear Barometer, another
measure the "pros" look at is exploding up, suggesting that smart money
is very scared right now.
I read the comment and then asked one of the best TAA pension fund managers I know to share his thoughts:
With vol at 15..it is reasonable for skew to be so steep. This market is a very low vol market, point in fact is 100 day realized vol on spx is below 12. However, it is prudent risk management to buy short term vol or gamma at these low levels because you benefit if a you have a big move in the markets. But the biggest anomaly is still long term volatility, which is sitting at 30. The past 5 years realized vol on spx is at 28. Unless you think we will have another banking crisis it will be very difficult for vol to realize this level. Interest rate curves are steep and the Fed hasn’t yet increased short term interest rate.
He added:
"...that is why I am moderately bullish..hedge funds are quick to short and real money is hedged.... We are climbing a wall of worry!"
We talked about the S&P debt warning on US debt and both quickly dismissed it as "bullshit". I want you all to repeat this sentence a trillion times: The US will never default on its debt -- EVER! Get that silly thought out of your head. It's beyond stupid and I'm sick and tired of the media fueling this nonsense.
Some
lady on CNN tonight was painting a "nightmare scenario" where the
Chinese "woke up one morning and stopped funding US debt". I was rolling
my eyes as I listened to this nonsense. The Chinese need the US
consumer and they're still an export-led economy. China's middle class
is growing by leaps and bounds but they're nowhere near the point where
they can wake up tomorrow and tell the US to screw off.
I'm also
sick and tired of hearing about how Bill Gross is selling US bonds (yeah
right!) and how the US is the next Greece. Total rubbish! When a
possible Greek restructuring hit the newswires, investors fled to the
safety of US Treasuries.
On the subject of Greece, that TAA
manager sold his 2-year Greek government bonds last week and made a nice
profit. On Monday, the yield on those 2-year Greek bonds rose to 20%.
On Tuesday, risk appetite was buoyed after Greek debt sale:
Athens
sold €1.625bn of 13-week notes and although the yield demanded by
investors was 4.1 per cent – up from the 3.85 per cent paid at its last
sale of these notes in February – there was healthy demand with orders for 3.5 times the bonds on offer.
I asked another sharp pension fund manager his thoughts on 2-year Greek bonds and here is what he had to share:
I’d want to buy ones with lower prices (discount to face); the assumption being that restructuring could take the form of a haircut off of face value. However, you don’t want to get too long a maturity, so you end up looking at 5- to 10-years. With short maturities, you’re playing the game of guessing how long they can delay any restructuring event, which we have no expertise in.
It looks reasonable from a risk-return standpoint even under the assumption that they will restructure; and if for some insane reason they don’t restructure, you make out like a bandit.
Even though Greece is forced to pay sky-high rates to borrow, and restructuring looks more likely than ever, I have a feeling some large hedge funds and asset managers are going to "make out like bandits" snapping up Greek debt at these levels.
As far as how low the VIX can go, it's anyone's guess, but it can go much lower and stay low for a very long time as the market continues to climb the wall of worry, which I predicted back in January in my Outlook 2011. There is a tremendous amount of liquidity which will propel all risk assets higher. Don't say you weren't warned.
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If my articles are ''crap'' why do you even bother reading them? Why do I get over 1,000 hits a day on my blog with top pension funds, wealth funds, hedge funds, gvt regulators, and ordinary investors? Think about that.
Because I hope that someday you will surprise everyone here and write something good.
if i might answer that: because almost all ppl prefer to read what they can agree with. So ur clickcounter is merely a good contraindicator :) Leo, the easiest way to destroy a brand, is oversupply in conjunction with a falling price. The FED destroys the brand 'US Dollar' and the trust people have in the US's willingness to PAY. I expect the longterm US Treasury prices will fall like a stone and maybe de facto default in 30 years, due to then worthless fiat money it was printed on.
Thanks alien-IQ, well said. I do not reply to all the comments, but try to reply to the intelligent ones. I ignore the trolls on ZH who are angry and vindictive people that offer nothing but insults.
If you don't agree with him, craft a reply that justifies your position. Don't just sling mud...any idiot can do that.
Perhaps you should direct that comment at Leo. He rarely crafts replies that justify his position, frequently doing nothing more than slinging mud.
The S&P was at 1,400 when we were already in a recession, both of the last two times in happened!
Yes, the market is wrong.
<<< tired of hearing the doomsayers here post utter nonsense >>>
Some people here wonder why ZH has given you posting rights.
Your head must be buried in the sand if you think engaging in trillions in defict spending and massive Fed intervention resulting in the destruction of the US Dollar are wise policies.
So what if you don't agree with him. He's got an opinion; and ZH benefits by other views...
I dare say 95+% of ZeroHedge readers wonder why the fuck Leo has posting rights here.
If we wanted pro-Establishment lies and surreal Keynesian economic propaganda, there are a multitude of "mainstream" media sources we could turn to instead. Just because the stew is very rich in meat does not mean that throwing in a turd is going to "balance" it out.
You sir, are so kind.........LOL !
I am in the 5%. I think we need more posters like Leo to give us some balance. I certainly have fallen into a "group-think" mode to the point that I lost perspective of the other side, the majority. I doubt we are 100% correct. It is always good to reflect our own bias against some other, opposite, view.
He's posting his own opinion as you do so it is ok, you can argue with him and put forward your own arguments against it and leave judgement to readers. Why you want to silence anybody? You know and I do too that 90% of people in US would have agreed with him, it's not in your own interest to get separated into small group of dissidents, you want more people to know your arguments, start to understand them and do something to change their future.
E U
"You know and I do too that 90% of people in US would have agreed with him"
To the extent that Leo posts his red meat on ZH, he either has the Napoleon complex or is a masochist.
Either way, most of Leo's messages are founded on "the Fed can walk on water"; we shall see.
Monetization, "QE forever" is currency debasement- the illusion of wealth.
Historically, the Fed had the world's largest Creditor nation behind it, today it is the worlds largest Debtor nation.
With no base to the (jobless) economy, Chinese vendor financing coming to an end, and only a printing press to support the market, Leo is getting closer to the edge of the ice.
Post away Leo. I hope you are right. I think you are wrong.
Well said, EU.
Waking [people] up is hard to do, eh?
No shit it's called The New York Times
<<< Just because the stew is very rich in meat does not mean that throwing in a turd is going to "balance" it out. >>>
Good analogy. Leo and RoboTrader and Harry Wanger would largely cease to exist from these threads if ZH would give us an ignore button. My guess is ZH won't do it.
Wrong again! I lost my job back in 2006 when I was ultra bearish and warned about the looming credit crisis. I call these markets the way I see them. I have SKIN IN THE GAME. No need to bullshit anyone. If you do not agree with me, good for you. That's what makes a market.
Why do you only wish to speak to, and hear from, other cheerleaders? Or do you wish to live your life as an example of.confirmation bias?
<<< Why do you only wish to speak to, and hear from, other cheerleaders? >>>
RoboTrader and HarryWanger are the epitome of cheerleaders.
<<< Or do you wish to live your life as an example of.confirmation bias? >>>
This is both insulting and absurd and doesn't merit a reply.
So we need to hear more from liars and amoral defenders of the corrupt sociopathic elite?
Your premise is insulting and absurd --- there are MANY of differing opinions who are not shameless apologists for the failing status-quo, as is Leo.
Leo is on the side of the parasites and tax-feeders. That being said, I do enjoy seeing (and posting) rebuttals to his ill-conceived ideas.
I don't always agree with Leo. I find it interesting that he understands how screwed the pension system is, but somehow thinks this won't affect the broader recovery, but I don't think he is a liar or amoral. I am glad he posts and ignores the insults.
I tend to agree. Having Leo post here gives us an opportunity to re-examine our assumptions from the point of view of the Mass Man, and refuting his simple assumptions keeps our wits sharp.
I hope akak will forgive me for suggesting that it adds nothing to the debate to characterize your opponent as a "Canadian asswipe troll". Canadians have similarly disparaging opinions about us fat American warmongering trailer-trash buffet queens. But Leo had the grace not to voice them. Just saying.
Believing that the collapse or rebalancing will not be as bad as some.people think in no way makes me an apologist for bankers.and.incompetent government
Leo, like the dyed-in-the-wool Keynesian idiot that you are, you refuse to acknowledge the difference between nominal and real.
With every little bit of depreciation of the US dollar, the US government defaults a little more. And when the dollar finally catastrophically collapses, the US goverment will effectively default on the US debt --- as countless numbers of other hopelessly indebted governments have done before them.
Or are you in the camp of Steve LIESman of CNBC, who disingenuously believes that merely because the US debt is denominated in US dollars, and because the US government owns a plethora of printing presses just waiting for the right time, that the US goverment cannot effectively default on its debt?
The money to pay down the debt, or even to continue to service the debt, simply does NOT exist! What part of that reality do you not understand?
Carry on, asswipe Canadian troll.
Leo does not understand what the VIX is. It is not an indicator of market stability. It is an index of how much fear of volatility resides in the options complex.
Much of what's in this article is simply wrong. The stock markets did not go "hysterical" at the S&P news. The 240 point drop in the Dow was a mere 2% move, and quickly corrected itself.
The VIX at 17 is not outrageously low; it was snoozing around 10 in 2007, until the Bear Stearns High Grade Structured Credit Dog Crap funds blew up. The VIX does that; it goes into snooze mode because everyone thinks nothing can go wrong. When they think that, they are all on the same side of the trade, and hell is about to break loose.
Story for Leo: I was trading VIX options in 2008. I knew we were headed for a crack-up, and I knew in August that the VIX was insanely complacent at 19. I bought a bunch of out-of-the-money VIX calls at .90, or $90 a contract. Why could I buy them so cheaply? Because the Fed had the markets convinced that everything was under control.
Then the rumblings about a possible Lehman failure kicked in, and the VIX edged up to 25, then 30. I sold all my calls for $140 a contract, and thought I'd done okay.
Then Lehman blew up, and the VIX soared nearly to 90. If I'd held those VIX calls for a week or so longer, I could have sold them for over $2000 per contract. Talk about leaving money on the table....
Right now, we have the exact same story. The markets think the Fed has everything under control, liquidity will be applied as necessary to make sure that nothing really bad happens. The Fed will float stocks through endless POMOs, monetize deficits no matter how large, lend money for nothing to the Post Office, Wall Street, the automakers, anybody. What could possibly go wrong?
The fact that the VIX is low suggests that we're about to find out the answer to that question.
IC- great post, thanks. Please post more of your insights.
I don't understand the VIX? Give me a break! You don't understand that we are about to head into a massive bubble and the VIX will stay low for a long time. It doesn't mean that negative surprises won't hit us, but so far the market has climbed the wall of worry and it will continue trending higher.
" so far the market has climbed the wall of worry and it will continue trending higher."
That is a non sequitur, Leo, and a disastrous one. It grows from the fetid bogs of Normalcy Bias. What you are saying is, "The market has been climbing for a long time, thus it must continue to do so."
But you forgot your own thesis: "The VIX is now at 16, so no one is worried, thus there's nothing to worry about." The VIX is telling you that stocks are climbing a wall of complacency, not worry.
Consider this, Leo: As autumn 2007 rolled in, the Dow stood above 14,000 after a five year climb. The VIX was in deep slumber at 10. Fed credit was floating everything; stocks, houses, bonds. No worries, mate.
What followed was an 18 month sell-off that cut the Dow in half, below 7,000. You forgot that already? No, Leo. You don't understand the VIX.
Great comment. People pin all their faith on the ability of the Fed to support the markets, without accepting that the more they push it away from the underlying risk/ return, the more certain a dramatic correction becomes.
Is the Fed selling Treasury puts?
Is the Fed selling VIX puts?
Doing either of these will certainly support the market, but it is incredibly dangerous unless the underlying economy is improving and deficits are being dealt with.
As I understand it from conversations with people who should know, there is a terrible fear that any sign of weakness in the market will set of a chain of events that will lead to disaster, so every problem (Japan, Greece, Portugal, Ireland, whatever) is countered with massive amounts of centralized support, but we are building a hugely unstable system (what you call in physics a critical steady state)
We are reaching the end of the road where the Fed has fought every downturn (i.e. tried to fight the laws of economic cycles) since the Dotcom collapse and all it does is increase the certainty and severity of a collapse in the future.
@ I C, excellent post, thanks.
The US is defaulting on its debt via Quantitative Easing.
QE is not defaulting on your debt but monetizing it. Countries that print their own currency will not default on their debt. PERIOD.
Zimbabwe never defaulted on their debt either.
Hooray.
exactly
Leo -
Can you say "defacto default " ? I knew you could .
When the time comes that you can pay of the debt for the price of a dozen eggs...that's 'Defacto Default'.
It is so low because everybody agrees that market will go this or other direction, it changes the most when there is difference in opinion on future direction of the market. And the opinion is ....? Of course they think it will go up! Isn't it?