Volatility

Upcoming calls from Ben and Mario to the governments?

Get your act together, there’s just so much that can be done.

Odd and contradictory ROn / ROff close

Sometimes a picture can paint a thousand words; in the case of these two charts from Nanex, it paints more as it is abundantly clear that since Reg NMS, the 'noise' in our daily trading markets has risen exponentially as the apparent price we pay for the 'liquidity-providing' machines is up to 15-times more normalized 'price-changes' - or put another 'smoothed' way: averaged over a 20-day period, intraday volatility has doubled since HFT began (and was six times larger during the flash crash). How's your mean-variance efficient-frontier look now? Or your delta/gamma hedging program?

We don't need recession

Or means of repression

Just give us some money

Our life could be sunny too...

A new and important bullish indicator for the gold market is that gold calls are at highs not seen since the October 2008 low as option traders go long gold in the belief that it will go higher. It suggests that option traders believe that U.S. Federal Reserve Chairman Ben Bernanke will hint at or announce additional money printing and monetary easing at the Jackson Hole, Wyoming, symposium. Alternatively, it suggests that they are bullish on gold due to the risks posed to the dollar and the risk of inflation taking off. The ratio of outstanding calls to buy the SPDR Gold Trust versus puts to sell jumped to 2.69 to 1 on August 24th and reached 2.76 earlier this month, the highest level since October 2008, according to data compiled by Bloomberg. Ownership of calls is up 26% since the July 20th options expiry. Ten of the most owned actively owned ETF option contracts are bullish. Option traders are regarded as savvier and tend to be more sophisticated then the more speculative futures traders.

In what is shaping up to be another listless trading day, where attention is glued to Hurricane Issac making not one but two landfalls, and the implication for US refining capacity or the lack thereof, here is what has happened so far, via BBG and Deutsche. The overnight session is mixed with Chinese equities under-performing again. The Nikkei and the KOSPI are both around two-tenths of a percent higher. The Shanghai Composite (-0.4%) is lower as the economic slowdown is adding negative pressure on cyclical sector earnings, closing at fresh 3 year lows. Iron ore prices continued to fall amid the weaker growth backdrop in China. Spot iron ore prices were down nearly 5% overnight to their lowest since November 2009. Rio Tinto's 5yr CDS has widened by about 25bp in a week. Rio's share price is down by about 6.6% over the same period. European markets fall, led by the commodity-heavy FTSE 100, with Swedish, Swiss markets rising. The euro rebounds against the dollar. Crude oil falls, metal prices decline. Spanish, Italian bond yields rise slightly, German, U.K., Irish bond yields fall. U.S. futures little changed and 2Q GDP figures are released later today. The state of Italy has sold EUR9 billion in 6 month bills at a 1.69 BTC, yielding 1.585%, the lowest since March, on prayers that Draghi, who was last heard defending the ECB as a non-political institution (whose sole product is the political construct known as the Euro - go figure), will finally step up and act instead of just continuing to talk and make empty promises.

Going nowhere fast was the theme today as equities managed to end practically unchanged (SPX/Dow down, NDX up) but intraday saw some very gappy behavior (though admittedly in a very small range). VIX is the story of the day in our view - realized volatility has dropped to near-record lows (which had, until a week ago, been a big driver of front-end implied vol compression) and yet VIX pushed higher (with implied vol now at almost a three-month high premium to realized). The point being - protection is bid, and a VIX of 16.5% is much more concerning given its premium than some would believe. Volume was above its very recent and dismal average but still around 15-20 percentage points below normal summer doldrums levels. Risk assets in general trod water today with modest outperformance by Treasuries (yields lower 1-2bps) and negligible moves in FX carry trades - even as the USD is down 0.35% since Friday (mirroring Silver's 0.35% gain). With Consumer confidence dismal, somewhat strangely both Consumer Staples and Discretionary outperformed on the day. Very low average trade size, a low high-low range, and a general inability to pull away from VWAP (+/-3pts only) suggested everyone is on hold (or buying protection as we noted above); but the small flush into the close was not very encouraging.

Greece’s climb towards solvency is steep and the underlying question remains; can the country return to growth and reduce its debt before it’s too late?

There are 3 solid rules to follow and understand when buying gold and silver bullion and or mining stocks. Here they are.

With the world's suckers investors (CEOs, politicians, and peons alike) all hanging on every word the man-behind-the-curtain has to say on Friday, Stone & McCarthy has crafted an excellent 'what-if' of key takeaways and interpretations ahead of Friday's Jackson Hole Symposium speech by Bernanke. Will Draghi toe the line? Will China be pissed? and what rhymes with J-Hole? On balance, we think Bernanke will save the policy directives for the FOMC meeting (potentially disappointing the market) while highlighting that the Committee is vigilant and flexible, and ready to act.

Yesterday, Jens Weidmann called it a "drug addiction"; for the past 4 years we have called it sheer insanity (and other less polite words). Whatever one calls it, it is obvious that using monetary policy to delay the need for real (not theatrical) fiscal policy involvement that sees to restore debt credibility (i.e., deleverage) does nothing to fix the underlying problems, and merely provides an ever briefer respite from the symptoms of insolvency without ever addressing the underlying cause. Today, even Bank of America has realized this fundamental Catch 22 that is now the paradox at the heart of what remains of capital markets: more easing serves to appease politicians, who see no need to change any of their broken policies, in the process requiring even more QE in the future, and so on, until this always ending in tears game of extend and pretend comes to a sudden and violent end.

Nanex's excellent and thorough analysis of sub-penny trade data doesn't support SEC's conclusions about internalizers as written in the final flash crash report. There is abundant evidence that internalizer software was acutely sensitive to the integrity of the consolidated feed and would switch off internal matching only if and only when the quote was crossed. Furthermore, short term volatility had little, if any impact on the number of sub-penny trades. About the only thing Nanex findings have in common with the SEC report on this matter, is that the date in question was May 6, 2010. This revelation, that internalizer software is sensitive to the integrity of the consolidated quote, means someone could manipulate the consolidated quote in order to cause internalizer software to reject valuable retail orders and spill them to dark pools or exchanges. This may explain the common micro-bursts of activity that occur throughout the trading day and cause a number of stocks to have crossed quotes in the consolidated feed - and implicitly open the broad market itself to these micro-bursts causing another flash crash.

Earlier today we showed for the nth time that with insanity and insolvency ravaging the old continent, at least one person has the temerity to avoid sticking his head in the sand of collectivist stupidity and denial. That person is Bundesbank head Jens Weidmann, who until now may or may not have had the backing of Germany's elected leader, Angela Merkel. Moments ago it became clear whose side Merkel, who recently came back from vacation and is set to spoil the party that the (insolvent) mice put together in her absence, is on. From Reuters, who quotes Merkel in her just released interview with German ARD: "I think it is good that Jens Weidmann warns the politicians again and again," Merkel said. "I support Jens Weidmann, and believe it is a good thing that he, as the head of the German Bundesbank, has much influence in the ECB."

The slings and arrows of outrageous EUR positioning remain key to figuring out where next in this on-again-off-again currency. The last six weeks or so have seen a dramatic regime shift from smooth transitions from risk-on to risk-off to more staccato-like jumps and trends as the world hangs on every rumor and flashing red headline. We note three things that may be critical to understand where we go next: 1) EURUSD has entirely recoupled with its EUR-USD 'swap-spread' implied fair-value - removing the 'chaos premium' in the pair, and providing less room for upside without broad-market agreement; 2) EURUSD has decidedly lagged the very impressive rally in European sovereign risk (suggesting the latter may be a little over-exuberant); and 3) Despite every talking head telling you about 'all the EUR bears', both Commitment of Traders and Citi's FX positioning indicator have shifted notably more positive - with the latter, as Steve Englander notes, beginning to show significant EUR longs. Now that an active segment of the market actually seems long EUR and associated currencies, the 'good news' bar is a lot higher, and the impact of bad news will be more readily visible.

We have critically examined the question of whether the stock market 'discounts' anything on several previous occasions. The question was for instance raised in the context of what happened in the second half of 2007. Surely by October 2007 it must have been crystal clear even to people with the intellectual capacity of a lamp post and the attention span of a fly that something was greatly amiss in the mortgage credit market. Then, just as now, both the ECB and the Fed had begun to take emergency measures to keep the banking system from keeling over in August. This brings to mind the 'potent directors fallacy' which is the belief held by investors that someone – either the monetary authority, the treasury department, or a consortium of bankers, or nowadays e.g. the government of China – will come to their rescue when the market begins to fall. 'They' won't allow the market to decline!' 'They' won't allow a recession to occur!' 'They can't let the market go down in an election year!' All of these are often heard phrases. This brings us to today's markets. Nowadays, traders are not only not attempting to 'discount' anything, they are investing with their eyes firmly fixed on the rear-view mirror – they effectively trade on yesterday's news.

It seems everyone and their pet Goldfish has been brainwashed into the belief that because it's an election year, we have to buy stocks. There is plenty of noise in that empirical study with some large outliers. However, Credit Suisse's Harley Bassman notes there is another cycle in election years - that of implied volatility - and he adds "the clearly defined economic nature of this election should increase implied volatility on most financial assets." As the chart below shows, volatilities tend to trough in August and peak in October into a November election - only to fall once again from two-weeks before to one week after the election. The pattern is clear.