Must Read: Is Volatility Broken? Normalcy Bias And Abnormal Variance

Tyler Durden's picture

Artemis Capital, which 3 months ago brought us "The Great Vega Short – Volatility, Tail Risk, And Sleeping Elephants" which has so far predicted the volatility regime in the new "centrally planned" normal to the dot is out with a new must read report: "Is Volatility Broken? Normalcy Bias and Abnormal Variance" analyzing the fascinating phenomenon of Negative Panic and how it translate into Negative Volatility. As Artemis notes: "The regime resembles a more extreme version of the volatility curves experienced between 2006 and early 2007 prior to the onset of the credit crisis. The new paradigm of volatility officially began after the May 2010 Flash Crash but the most extreme changes have coincided with announcement of the Fed's second quantitative easing program in late-August." What does this mean for capital markets in the new normal: the stunning conclusion: "As the economic recovery has taken hold many people are cheering a return to normalcy, hence driving spot volatility lower even as many systematic risks remain unaddressed. The optimistic case for markets going forward is supported by improvements in the labor market, much higher asset prices, and the best corporate profits in a century... but something just doesn't feel right. The steep volatility curve and high skews are a reflection of this unease. In the end it is hard to come to terms with this sense of normalcy while looking at some very abnormal facts. For example, is it normal for the US to pass China as the largest holder of its own debt? Is it normal for the Federal Reserve to purchase an estimated 70% of the new supply of that debt5? How can inflation be normal when a broad cross-section of food and commodities appreciate 23% in only six months?6 Or when global inflation contributes to violent protests, revolutions, and war that spread across the Middle East and Northern Africa causing oil price shocks? Can we say it is normal when the European Union bails out its third member nation in under a year? Or when the Swiss Franc appreciates nearly +30% against the USD in only nine months, cancelling out a +27% gain in the Dow Jones Industrial Index from currency devaluation alone? Why is it so easy for markets to return to normal after a massive disaster in Japan threatens the financial viability of the world's third largest economy and purchaser of US debt? Each and every one of these facts is a fire burning on the wings of the economy. The markets may be passive but not without hidden fear.
The denial of truth is the denial of volatility."

Is Volatility Broken? Normalcy Bias and Abnormal Variance (pdf)

Artemis Q1 2011_Is Volatility Broken

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narapoiddyslexia's picture

De Nile is a river in Eqypt. What we do is called kicking the can down the road.

CPL's picture

Anyone that day trades X3 etfs could have told you this three years ago.   Reason why I calculate every variance in a spread if trading them.  At one point I made the attempt to flip the idea of VIX into it, all I ended up with was butter and shit soup. 


Example FAS/FAZ/Russel.Fin indez versus the VIX.  guess which was the odd man out.  We are trading against machines.  Machines with rules.  All machines have hacks.  Use the hacks to win and keep a tight stop loss in place to escape...even if you are out in two seconds...all that is lost is the trade fee.


Anyone that wants to play around with them I have the older versions up for all to play with and no I don't send my newer versions out, even to friends anymore.  I did years ago, but found that people were getting hurt by them or missing their shot.  Use at your peril because of the nature of the vehicles involved investing.

It's evolved a bit since then, now it has my own HFT gear behind it and no, it's not forsale.  I like making money.

AldousHuxley's picture

The real question is not WHAT is normal since the definition is relative....but WHY.

Could it be that the current holders of power are afraid of challenge to the status quo?



Translational Lift's picture

Don't wooory.....Be haaaapy.......

smlbizman's picture

lets look at our recent puzzle pieces, gross sells, gs closes commodity thingy, transitory inflation speak from the fed{s} because we are going to do something that will "effect" or "affect" all commodities.....a rate increase?

treemagnet's picture

Volatility can't be broken - its just dormant.  This things gonna light up like a tire fire once the winds pick up.

Djirk's picture

go back to bed america, your government is in control....nothing to see here, keep shopping with your credit cards

Boilermaker's picture

Exactly how is this different from Euro-land?

alien-IQ's picture

they have better restaurants.

Djirk's picture

depends on where you are in euro land? at least some countries and consumers are saving here. Not to mention they make the hard political choices like austerity and extending the retirement age.   not to say there are not problems

Manthong's picture

Obviously, the Fed has retained Dr. E. Nygma and he has deployed his brain sucking device all over the country. That must be the case because NOBODY I know socially has a freaking clue about what is being done to them.

alien-IQ's picture

Volatility is soooo 2007. No more need for it. The market is now, thanks to the Chairsatan, blue skies and blooming fields of flowers next to an ocean of champagne populated by naked supermodels willing to fulfill your every fantasy...and Unicorns...lots and lots of unicorns.

Racer's picture

Stock prices have reached what looks like a permanently high plateau.

Muir's picture

At worst, maybe a little froth on the Cappuccino.


(ah, yes, oldies but goodies)

William Wics's picture

Thanks! I love it when someone trots out Irving.


Boilermaker's picture

Isn't there compelling / overwhelming evidence that the Fed is manipulating damn near everything?

RockyRacoon's picture

Yes.  Hence, the famous saying, "There are no markets, only interventions."

RunningMan's picture

A bit of a dense read. One takeaway is that volatility has been artificially suppressed as a result of Fed intervention, but that can only be part of the story. Surely abnormally low volume is a second aspect - and this piece doesn't seem to acknowledge that.  I saw a statistic that 85% of people responding to an online poll said they had gotten back into the market since 2008. I fould this surprising (granted it was on cnn, so veracity could be questionable), but seems contradictory to cash staying on the sidelines.

All I can say is observed volatility in the market is low, but tensions are very high.

Translational Lift's picture

"All I can say is observed volatility in the market is low, but tensions are very high."

Kind of like a woodie in a tight pair of Jockie's.....

Urban Redneck's picture

Artificial volatility suppression- Sergey Aleynikov was imprisoned because he got his hands on the code for Goldman's buxnet worm. It is an insidious cyber-warfare WMD which only infects HFT computers and passes around single shares of stock at higher and higher speeds to drive up the market, until there is a meltdown. Unfortunately, like the stuxnet worm, it has the same fatal design flaw in that it does not actually stop the underlying action of the machine controlled, in this case the front-running and financial rape of the of the few actual traders left in the equity market.

Bansters-in-my- feces's picture

Speaking of volatility,I see silver got the double barrell aroud 3:00 pm bythe JPM HSBC tag team FIRING SQUAD.

Muir's picture

"High Volatility Skew


The new volatility regime is characterized by an increasedexpectation for extreme price movements, as exemplified byelevated levels of implied volatility skew for far out-of-the-money options. Skew is an important indication of whereinvestors are placing leveraged bets. In essence, skew measuresperceived tail risk.The normalized skew for SPX options has been increasingsince early 2009, but the unusually robust skew for far out-of-the-money index options signifies a greater than average probabilityof a large price dislocation over the next five months. Forexample the volatility skews for options that are 40-50% out-of-the-money are now close to their highest levels in a decade (seechart to the lower right)."
- Makes sense. Either QE or a sharp decline. Nothing to see here, move on. -


6 String's picture

Short Russell 2000, bitchez. 50+% return in 6 months.

Double down's picture

Really good read.


Thanks TD

Strategery's picture

There is no more free market. Risk means little for those using no interest money in a house rigged game. For the average investor, technical and fundamental analysis might accidentally get you the right answer on direction, but don't consider it any more than a wild guess based on mental processes that once had meaning. Now the only thing that us relevant is knowing when they are going to pull the plug on artificially holding up the market (or when the unknown nature of the markets has been pushed to the point that the Fed could not anticipate). What the market has already assumed is also a wasted mental exercise. It may appear that the market has already factored in this event or that, but frankly any likeness to this analysis is merely serendipitous.
Those receiving direct or indirect Fed benefit should be excluded from the free markets!!

Handle with care's picture

I agree.  The market is no longer a pricing mechanism or a way of distributing capital to where it will generate the greatest returns, but is merely a casino in which players bet on which number the Fed is going to pick for the ball to land on.

6 String's picture

Yup. QE3=PM's up, Commodities Up

No QE3=Disorderly chaos.

It's why it seems most, even at ZH, actually hope QE to infinity because at least many will get rich off that plot.

The no QE, then again QE, is just harder to trade. So, we must all adjust accordinly and quickly.

Nassim Taleb is probably long out of the money calls in P.M.s and commodities.....and short stocks out of the money. While simultaneously betting against UST's.

Rynak's picture

People like to blame the absence of the original purpose of market purely on intervention. While intervention and manipulation surely is an important aspect, i think that another aspect is just as important. Why do people trade? Why would one buy or sell something? Originally, you would buy because you need something, and sell because you do not need something. I'd even go as long with saying that one would also buy, if one assumed, that the good would be needed later in the future, and sell if one thinks that it's demand in the future will be low (this also covers longterm stocks).

What do all those assumptions have in common? That supply and demand as in ACTUAL production and consumption are the primary driver of price.

How do those assumptions stack up to short-term trading? What if the considerations about price are no longer about what is actually needed, and actually produced, but plain and simply about "imagined" supply and demand? To explain what i mean with this: If your considerations about buying and selling something, are no longer about actual demand on the ground, and actual supply on the ground.... but instead, purely imagined S&D... so, predicting how other TRADERS will act (rather than how producers and consumers act)... then the price is no longer mostly driven by production and consumption, but instead strongly affected by mental games of traders.

Atch Logan's picture

So, am I reading this correctly:  the Fed is controlling the volume of the markets, and now it is controlling the volatility?  In other words, the alter-government is running our capital system. 

So, why am I voting, why do we even elect anyone? 

So, we are electing idiots who do what?  Rubber Stamp the Fed?

Translational Lift's picture

Most of the A-holes in DC work for Wall Street in one way or the other........Uh.....guess who the Fed (is owned by) works for????............

SheepDog-One's picture

All a scam, why pay taxes? Why not just have Bernanke print your return? Because taxes make good slaves....the whole thing is designed for 1 thing- humanity is just a Coppertop battery designed to pay interest.

X. Kurt OSis's picture

Even with the post Japan reversal in vol, the hedge worked out pretty well for me.  Pairing equity vol with long pm's seems to be a pretty good way to play this environment.... if you assume anything is ever going to make sense again... which is a pretty big if.

gordengeko's picture

Those are some preettay looking charts, I like the 3d effect!

Dan The Man's picture

Everybody should be long PM's just in case amerika incredibly, digs themselves out of this....  And have the physical metal in case the don't.

Cdad's picture

You just have to love it when some criminal syndicate Wall Street firm acts all confused about what is up with the Vix.  Funny.  LOL.

24 months worth of naked short selling, in combination with 24 months of the VXX and VXZ creation units machines working 24/7...and what you get is...anything but...price discovery.  And that is exactly what the criminal syndicate they pumped an equity market rally on an entirely artificial catalyst [Ben Bernanke].  

As for all the things that the Vix is here.  However, as has been said by many...this ain't no market.  Anyone trying to tell you that this is still a market is quite the joker.

And therein lies the rub...the rub that the criminal syndicate known as Wall Street would simply like to side step right now.  Good luck with that, trying to rebuild market integrity on sandcastle foundations and unicordew dreams.


SheepDog-One's picture

Yes Cdad, theyre all so confused, befuddled, BAFFLED even! Hmm whats up with this volatility gee we really dont understand whats going on at all. Well lets remove Bernankes $8 billion daily gift to banks to buy equities free of charge, and lets raise some rates from zero or negative to just 2% or 3%, let the markets stand on their own without pre-market levitation magic and lets see what happens?

SDRII's picture

Calling Kid Dynamite?

Trillax's picture

Veeeerrry interesting.  Never heard of this analyst until now, but I like his research and his conclusions. Thanks for sharing this, TD.

poydras's picture

One should be unsurprised at almost any market dynamic considering the extent of intervention to date.

AldoHux_IV's picture

When all the players that would be increasing the vol structure are too busy BTFD on increasing margin, who's got time to worry until the needle of liquidity is removed from the vein of capital markets.

JR's picture

All arguments and free enterprise market analyses are moot exercises until the Federal Reserve System is uprooted from America’s economic field, and burned.

Nathan Martin of Nathan’s Economic Edge wrote today:

“[O]ur own politicians are captured by corporate interests…

“This situation highlights the failure of government to work on behalf of the people – something I contend began in the year 1913 with the implementation of the criminal ‘Federal Reserve Act.’ It’s criminal because it isn’t ‘Federal,’ they don’t have meaningful reserves, and they aren’t even a bank.  They are a private corporation owned by other corporations created for the sole purpose of hiding the trail of money and disguising the fact that Congress was conned and bribed into relinquishing the money creation power over to a few individuals – and since that time progressive capture of government, regulators, and all markets has occurred non-stop and in a methodical progression.

“The very function of and concept for the existence of corporations has been turned upside down.  Take General Electric for example.  They are the last remaining original DOW Industrial, but they, too, in fact failed after going into the money production business and leveraging themselves to infinity on bad debt.  They failed, and we bailed them out. Now they don’t even pay taxes and their CEO is appointed by a captured President to help turn around the economy!  I’d cry if it weren’t so hilarious.

“This is the same company that designed and helped to under-build the reactors in Fukushima.  Now, the same private company that is allowed to manufacture money and to use that money to lobby politicians (and doesn’t pay taxes), also owns a very large swath of the media and thus what you are hearing from their media is far different from the reality that your are hearing form me – as I am not conflicted and am genuinely worried about our health and about the path of our nation.  That worry is far different from GE, the corporation’s worry.  They worry about never ending growth, never ending profits.

“And thus our government and corporations no longer are working to the benefit of humanity; they are working against humanity.

“This brings us to a dire situation in which what most people believe to be an effective political process is not really effective anymore at all – it is meaningless other than as a tool to distract you and to make you think you have some input into the system, which you do not.

“The real power in a sovereign nation is in the power to control the production of money….that power MUST reside in the people’s hands in order for their vote to have any meaning.  If it does not, then those who create the money will use it to override and to rule over the people – and that is exactly what has happened in this nation and now to the world.

“It is now impossible for the people to straighten out the situation through the ballot box….

“Creating change that can attack the root of the problem and that can change the power of money creation back to the people will require dramatic action – it will require the people to somehow topple government and force the ‘Fed’ to be dissolved.  I don’t know how that can happen, but via revolution, world war, or just flat out economic collapse, it will happen, it must happen…

hambone's picture

This is too nuanced and complicated to be widely understood and belived by the American populace.  Unfortunately, once Americans are mad enough a substitute false flag enemy will be placed in their sights and all will be told "they" are responsible.  "They" will be different than "us" and will naturally fill our need for venting.  It will be bad speculators or MENA countries trying to destroy us "because they hate democracy (apple pie, and Chevy...they may actually hate Chevy???). 

You know TPTB play book and can see the play coming, you can call it out and make it clear it's coming...but I don't think it can be stopped.

Sorry to be sooooooo cynical but American's seem to prefer the easy answer that requires little to nothing of them.


falak pema's picture

We seem to be looking at the same coin from different angles and coming to the same conclusion : it's not pure gold and it's getting diluted every day to some cheaper form of metal by Ben the alchemist. One day it will be zero gold and there will be zero hedge play on it. Time to change trains and say goodbye 'greenback' from Benquack's FED vault.

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MacGruber's picture

This is a lot of data but I think it boils down to a simple concept in physics, "signal-to-noise", as the underlying trend gets stronger the variance goes down. I don't think this is something the Fed is intentionally doing, it's just a product of the perma-pump on record low volume. Understanding Ben's lack of sophistication so far I'd say this is just a lucky ancillary gift for them.