We asked one institutional manager who utilizes VIX related ETFs/ETNs in the portfolio construction process, Christian Wagner, the Chief Investment Officer of Longview Capital Management, his thoughts. Wagner stated:
“There is no question that the volatility based securities traded parabolically last week. We witnessed an extreme shift in the volatility of the S&P 500 than is to be expected. Unfortunately, yesterday’s data is not a good gauge of how to measure tomorrow’s results, particularly as it relates to volatility. As of last week’s close, only 28 of the 500 components of the S&P 500 were in overbought territory, leaving a staggering 94% of the benchmark ‘oversold.’ Believing that volatility will remain constant at these levels and that increased volatility will presage a further increase simply is not a part of our strategy. Volatility hedges are a constant component in our strategy and we are using these price extremes to book some nice gains and rebalance our hedges.”
Will intraday volatility with such extreme swings as we saw last Friday resume this week and in the near future in the equity markets? The answer is perhaps, and if so, holders and traders of VIX related ETFs or ETNs should be quick to refine their current expectations of how these products function and normally “trade”. For a market environment where the VIX is trading with a $15 or $18 handle is starkly different than one where the VIX is trading in the $30s, much less $39.25. That said, holders of VIX related ETFs or ETNs can potentially use this extreme intraday volatility to their advantage by taking the other side of such moves.
The problem is, the moves themselves, such as the VIX spike to $39.25 (where related products such as VXX traded at $33.25, VXZ traded at $57.78, TVIX traded at $40.65, and XIV traded at $10.57 for instance) can be extremely short-lived, and literally impossible to act on and aggressively trade against. Those who noticed that XIV traded at $10.57 on Friday and thought it a screaming buy (thus the VIX itself a screaming sale, since XIV is inversely connected to the VIX) were unlikely to have a chance to realistically buy XIV shares at $10.57, or even if they tried to pay all the way up to $11.00 and beyond because the VIX immediately regressed from the highs (taking VIX related ETF/ETNs with it), and simultaneously equity futures bounced from the intraday (and recent lows). The speed of these price movements and the levels of recent intraday price ranges compared to historical intraday ranges has surprised a great many in this market in short order, and thus market makers and liquidity providers such as high frequency trading firms have certainly “widened their parameters” when committing capital and trading against customer order-flow and in trading firm capital.
The extreme price volatility and speed of recent price movements has created potential trading opportunities, but for the average portfolio manager or investor, reaction time will likely just not be quick enough to realize a good trade when it presents itself. That said, a potential strategy to employ, especially if these conditions in the equity market continue, with daily “macro” headline risk existing in the marketplace and influencing the tape to a large degree, would be one of “bracketing” buy and sell orders at what would normally seem like “well away” orders, either on a “Day” or “GTC (Good Till Cancelled)” basis. For example, selling VXZ last Friday anywhere above $57.00 or buying XIV below $11.00 now look like fantastic intraday trades, based on the fact that the moves to those extremes was so short lived, and an immediate price regression in the opposite direction occurred just as these levels were touched.
However the only realistic way for holders or users of these VIX related ETFs and ETNs to book large intraday gains by taking the other side of such extreme moves is to put out limit orders on either side of the book (Buys or Sells), at some “factor” around the current levels of where the products are trading themselves. The price levels orders should be put out at should not be completely unrealistic, i.e. trying to sell VXZ at $100 on an intraday basis with the product trading in the $50s is very unlikely to yield good results, but at the same time can be “wider” than usual given the current market environment and the potential for short term gapping effects due to what seems like less liquidity being available in the overall marketplace during quick, unilateral price moves in the market indices. Then, by monitoring the VIX itself along with overall market activity, one can tighten or widen their parameters and sensitivity based on where the intraday patterns are themselves versus historical volatilities.
Last Friday’s extreme move in the VIX and related ETF/ETN products was a true eye opener to both institutional and retail users of these products, who should never lose sight of the fact that they are trading “volatility” as an asset class, or essentially “human” or the “market’s emotion” in the form of fear or complacency, and an asset as such, will certainly not always act rationally, if at all.
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