Volatility

In addition to everything else, The Fed is now in charge of the VIX: "There is compelling evidence the Federal Reserve is artificially suppressing spot volatility through the quantitative easing program. Consider the chart below that shows how the VIX and the S&P 500 index performed on days when the Federal Reserve purchased US Treasury bonds as part of QE2 compared to days without Fed intervention (November 10,2010 to March 30, 2011). On days without debt purchases the VIX index was up +2.14%and the S&P 500 registered as light decline. On days with debt monetization the VIX dropped-0.45%and the S&P 500 index increased. What is even more convincing, the greater the amount of the debt monetization the larger the corresponding drop in volatility and increase in stock prices. During the 44 days on which the Federal Reserve purchased $7 billion+ in debt or more the VIX index dropped-0.57%and the S&P 500 gained0.21%! The connection between lower volatility and QE2 is undeniable. It is not hard to imagine that spot volatility would be much higher absent government intervention in markets. The artificially low volatility in markets may contribute to a dangerous build up in systemic risk."

When even Goldman's summary update on Ireland, which conveniently ignores today's news that the country may be preparing for a senior bondholder haircut and most certainly ignores last week's dump of Irish paper by LCH Clearnet from the repo market), is unable to find much if anything good to say about Irish bonds it is really time to get out of dodge (not like anyone was still left in it). The kicker in Francesco Garzarelli's just released analysis: "With around EUR 30bn worth of senior bonds maturing in 2011-12 (40% of
which is not already government guaranteed) and under continued
reduction of funding efficiency of the covered bond program, rolling
over maturing debt remains indeed one of the biggest challenges faced by
the Irish banks." Everything else is noise. Add to this the Portuguese government crisis, its own funding crunch, and the rapidly deteriorating German political crisis and Europe will be a very fun place over the next few months. In fact for once we agree with Goldman: "In light of this, Irish bonds [ZH: aka Paddy Paper] will continue to exhibit high volatility, in our view."

As is customary in these times of uncertainty and economic turmoil, the quite timely intellectual giants at the ratings agencies pull up to a burned down house stating that they smell smell something asunder.
Alas, better late than never and yet the Greek government seeks to have even that very late Truth... "Adjusted"!

It's not quite a triple forward (or inverse) ETF on gold just yet, but it's a start. Capitalizing on the surge in volatility in the commodity space, which together with FX has become the go to arena for day traders seeking volatility, which has been completely eradicated from stocks courtesy of the Bernanke Put, the CBOE and CFE have "announced plans to launch futures and options on the CBOE Gold ETF Volatility Index (Ticker - GVZ). Pending regulatory approval, CBOE Futures Exchange (CFE) will begin trading GVZ futures on Friday, March 25, and CBOE will introduce GVZ options a few weeks later." The reason for this product to be pushed on investors is that after peaking near 25 in December, the ^GVZ has plunged to one year lows as gold has steadily remained just off its all time highs. So if the first volatility derivative isn't generating the much needed commission broker P&L, it is time to break out 2nd and further vol derivatives. We expect a triple or more-leveraged ETF on gold and silver to arrive shortly, then followed by an ETF which tracks the theta in the first ETF , and so forth, until the entire market is dominated by "synthetic CDO-like" derivatives and nobody cares about the actual underlying, just so traders have something to keep them occupied. After all diversion, is half the battle.

I'm putting together what I see as solutions for the many pricing and valuation problems that I see coming down the pike. If you think real asset markets are a little soft now, wait until rates are controlled more by market forces than by concerted central planning cartels.

For technical reasons already discussed, I am generally bearish on US Fixed Income for the near/medium term. What bothers me with the way we have traded is that since December we are essentially stuck in a range which is much more reminiscent of a bear flag than a bottom in the long end. Also, while implied volatility has come in a lot since the local lows of 12/15, realized volatility is actually very high in Fixed Income. As a matter of fact the spread between Fixed Income realized volatility and Equities realized volatility is at historical levels. Lastly, while in this ZIRP environment sell-offs have been associated with steepening of the curve, given the reflation arguments in vogue and all the hype about inflation, it would make sense to see this sell-of capped by some proper pressure in the short-end or at least the belly of the curve. We caught the bounce from 103 in 10s30s up to 120 but here I suspect pressure on the curve in the long end is about to return. To better illustrate these last 2 arguments, we were able to buy for our clients some 99.00 puts expiry February on EDH2 for only 5bps on Wednesday. Knowing that hardly 2 weeks ago the contract was trading at 98.85, it seems that implied volatility was quite shy of reflecting what is realized in the market. This is indicative of a quite high level of complacency despite high realized volatility. I have added charts for the 10Y US Treasury future. Targets indicate targets of 117-14 to the downside at the minimum. The support of the recent range is 119-20, this will be the acceleration level confirming the next leg lower is on its way. For the Bund I had already specified I was looking for a move towards 121.45 at least.

Who would have thought that all it takes for a proposed ETF to be pulled is a complete loss of faith in the underlying. Today, Vanguard has announced it has canceled plans for a short, intermediate and long-term muni ETFs. "We believe that this delay is prudent given the high level of volatility in the municipal bond market, which began in November 2010 and continues today," said John Woerth, spokesman for the Valley Forge, Pennsylvania-based firm. "This volatility could impede the funds' abilities to tightly track their respective benchmarks, deliver on the funds' objectives, and meet shareholders' expectations." Well, what if shareholders expectations were to short the ETFs? It would certainly meet that particular set of expectations.

In the eyes of this volatility trader the current paradigm of monetary and fiscal stimulus may best be understood as the greatest leveraged volatility short in economic history. The current stimulus is analogous to continuously rolling "naked" put options on the global economy, backed by margin provided by the US taxpayer, generating short-term growth at the expense of long-term systematic risk. The reinvestment of the premium into risk assets by the investor class ensures the Fed's naked put is never exercised. In theory the Federal Reserve is now the largest volatility trader in the world...You've most likely heard the old adage about the danger of picking up pennies in front of a steamroller. The great volatility short is no different in principal as our government collects trillions of pennies from the treads of a debt steamroller repatriating them to the driver in exchange for a promise to slow the machine. We must hope the operator is able to find a better job before he becomes dependent on those pennies for his survival. At 9.4% unemployment it will be challenging. In a recent letter to senior members of Congress Treasury Secretary warned there will be "catastrophic economic consequences" if the government's $14.29 trillion debt ceiling is not increased immediately. What should be apparent by now is that one day the greatest volatility short in history will face a margin call the US taxpayer will be unwilling or unable to meet. While the markets remain in a state of euphoria it may be the right time to opportunistically position yourself on other side of the Fed's volatility trade by going long tail risk.

We have been claiming for almost half a year now that with the policy tool known as stocks now completely irrelevant, the places where traders can still find some Fed-free volatility (for the time being) is in the FX and bond markets. We are confident that in 2011 the MOVE bond vol index will be far more relevant that then the VIX, and that 200 pip daily moves in key FX pairs such as the EURUSD will be a normal occurrence. As validation of the first, just after the NFP number was announced, it was not US stocks, but the massive German treasury market that was halted due to a surge in volatility. This bears repeating: the massive, presumably liquid, and critical sovereign debt market of Europe's biggest economy was halted! We look forward to many more such examples of connected vessels, as computer, robots and the few remaining homo sapiens traders, pursue only modestly manipulated markets in which to trade volatility.

As of right now, the spot VIX has dropped to 16.80, the lowest it has been since April 20: rumor is that Goldman is dumping all its legacy OTR long vol positions in a year end clearance event. Ironically, as the VIX term structure chart shows, this is virtually identical to the shape of the VIX curve last seen on April 20, just days before the prior year end high was hit and followed by a substantial snapback. Then again, in a market in which the TICK reading has been negative virtually all day and stocks are higher, there is no point in even attempting to predict what may happen. It appears the POMO market makers are celebrating the Chairman's birthday and bypassing the bond market entirely, going straight into stocks: after all what better present for the world's biggest Central Planner than some serious wealth effect creation... for 10% of the US population. Incidentally, the real POMO, that of $8 billion in 7 year-ish bonds will conclude in 5 minutes.

The MOVE index measuring bond volatility has hit 112, a 2010 peak second only to the turbulent days following the flash crash and the first European bankruptcy. And speaking of European bankruptcy, CDS on Italy is back on the upward sliding track, last seen at over 200 bps, over 10 bps move on the day. And since there is no volatility left in a levitating market, the only market that vol hunters are now pursuing is the sovereign bond and FX markets. If and when intraday gyrations in the 10 year approach the equivalent of a stock VIX of 20+, then Bernanke will have finally achieved his goal of complete subjugation of the Banana States of America.

Both gold and silver are having a rough day to say the least. After a forced slide in the gold complex pushed the metal to sub $1,380, fueled in part by recurring rumors of a large macro/commodity fund taking profits ahead of the year end, numerous stops were triggered, bringing it to nearly $1,370, almost $50 below the all time high reached, oh, yesterday. And since traders are now desperate for volatility, which has disappeared from stocks, the daytrading crowd has taken over both the precious metals space... and the bond market. That said, momentum chasers entering the gold and bond market may have the makings of the greatest comedy witnessed in markets in the past several years.

In addition to the rout in the ES, VIX and GC which we pointed out earlier, there were some additional fireworks behind the scenes in today's after hours session. The CBOE Gold Volatility Index, the ^GVZ plunged by the most in over a year, as the index hit an all time low of 15.92 without the underlying making much of a notable move. The most curious aspect of the trade was that the entire dump occured in the AH session. Many were left scratching their heads over what caused this monstrous unwind in long vol positions: was this the unwind of a massive long ES/short GC arb? We don't know, although if rumors that a major fund is planning to stand for delivery of Dec gold turn out to be true, then obviously someone got confirmation today. Keep a close eye out on the GVZ. Should this price level persist on Monday, then the front futures contract will likely surge.

It was another lackluster day in the market as investors are still trying to regain their bearings from last week's quadruple news high of elections, QE2, the jobs report, and Kat Dennings nude photos being released. With all of the excitement...

The following observations by John Lohman are a must read for all mean reversion junkies. By tracking the correlation between credit expansion and assorted metrics of volatility, Lohman concludes that the one primary tradeoff given up by the investor class (voluntarily) and the broader population (unknowingly) in exchange for a 98% decline in the value of the dollar, and thus purchasing power, since the inception of the Jekyll Island monster, is a constant and gradual decline in volatility. What this means, however, is that by entering the period of greatest systemic deleveraging, America is once again inviting volatility. What is more troubling is that unlike before, the ongoing dollar value destruction is not matched with a favorable attribute, namely an offset vol reduction. In other words, society and the investing class has gotten to the point where the marginal utility from having a Federal Reserve bank, has essentially disappeared. Which is simply all the more reason to disband the most destructive central-planning organization in the history of the communist world.