Wednesday of Options X -- The Low we put in Today, was that the Bottom you were looking for?

Fari Hamzei

Not exactly !!

I was asked that question a number of times earlier today, both by professional and institutional traders.

IMHO, the market is following the Script we put out two Sundays ago on this blog (see http://hamzeianalytics.blogspot.com/2007/03/market-timing.html).

Our Script calls for a volalitity retest in the +4 to +5 sigma region. That should translate to a test of our last May 2006 high (~1326 on SPX), now acting as a critical Support. If that support level does not hold, the next logical stop is 1280 on SPX (July 2006 highs).

Here are two Volatility Indices that we follow very closely. (I am in the Prof. Robert Whaely's camp (the orginal VIX inventor), now called VXO -- and yes, I don't like the new VIX, as it has to do with its construct).


During this vol retest, we should see the VXO between the high 20s to low 30s, and

We should see VXN in the mid 30s before the dust settles. As far as its timing, with this week's quad-witching March Expiry as a backdrop, market should sell thru Friday and Monday ahead of Tuesday which happens to be Vernal Equinox (First Day of the Spring or "Norouz" in Persian).

Volatility Squared

Sally Limantour

Carry traders are in an option buying frenzy with implied volatility on a 1-month dollar-yen option moving to its highest level since Aug. Some are predicting a 10% move by month end. As mentioned here these last two weeks, volatility was a screaming buy in many asset classes – not just stocks and the VIX. Meanwhile, the 30-day statistical volatility of the volatility indices more than doubled overnight!

Yesterday’s Chicago purchasing manager’s Index for Feb. came in at 48.7 and anything under 50 is not particularly healthy. In addition inventories rose sharply to 54.5 from 41.9 which is bothersome as is the new home sales number in January, which fell 16.6%. With the medium/long term models still on a sell signal from last week and the short term model on a sell from Tuesday morning, my view remains the same as Monday – continued weakness with increased intraday volatility that will make day trading a fun job again. Witness this morning’s sharp break and rally, something nimble traders welcome. Until we get solid closes over 1429.00 in ESH7 and models turn at least neutral, I will stay defensive while taking advantage of intraday extremes.

Bernanke said he did not see a “real trigger” for the sell off on Tuesday. I wholeheartedly disagree as mentioned in, “the great unwind.” He also said he doesn’t see any real issue with liquidity. This statement is causing mixed interpretations. Some think he is communicating an ongoing “Greenspan put” (which refers to investor faith that the Fed will always combat market declines) while others think he means this is not the Greenspan Fed and we should not expect rate cuts if financial markets get wobbly. You choose, but remember it was Bernanke who in 2004 during a Q&A said, “I think it’s extraordinarily difficult for central bank to know in advance or even after the fact whether or not there’s been a bubble in an asset price.” (Note to self - watch the charts. They speak volumes without the ambiguity).

On dips, I continue to add to volatility positions in currencies and stocks and added to long positions in yen, gold and silver while moving up stops in the agricultural sector to protect profits. The metals and agricultural sectors have been outperforming and corn is up 90% since first writing about the bullish outlook.

Volatility -- My Two Cents

Fari Hamzei

We have enjoyed a Low Vol environment fueled by tremendous global liquidity that began approximately about a week before Gen. Tommy Franks commenced his precision air campaign to get rid of Saddam Hussein's atrocious regime. This coiled-up Un-Vol got adjusted yesterday. It always does. In all cases, we revert back to the mean, after a strong retest. To put it all in proper perspective here are some sigma channel charts:

On October 27, 1997, the DOW dropped 554 pts, SPX dropped 65 handles (-6.9%) while VIX went from 23.17 to 31.12 (up 34%) which made VIX hit its +4 sigma channel (63.34 per million probability of occurrence) if one assumes options prices are normally distributed – after all VIX is a multi-way MIV calculation of SPX options. The following day, one of the greatest speculators of all times, the legendary statistical anomaly trader Victor Niederhoffer, closed all of his funds.

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In August thru Oct 98, leading to the LTCM debacle, when some of Wall Street’s best and brightest went bankrupt, the big VIX day was on Monday Aug 31st. Dow was halted after 550 pts drop, SPX dropped -6.8% for the day and yet VIX only went from 39.6 to 44 (11%) and sigma channels chart shows it hit its +2 sigma and change area (1.24% probability of occurrence)

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During a more recent market sell-off, on April 15, 2005, VIX went above its +3 sigma channel, as the SPX sold off -1.64%;

and on May 15, 2006, after a two-day SPX rapid sell off of 31 pts, VIX only hit +4 sigma.

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Yesterday, we saw a 6 sigma channel move in VIX. This was truly an extraordinary event. DOW dropped 416 pts, or 3.3% (max drawdown was -546 pts) -- SPX dropped 50 handles or -3.47% and VIX shot up 64% and hit its 6 sigma (1.973 per billion probability of occurrence).

And for comparison only, here is yesterday's VXN chart (NDX Vol Index) -- notice it only hit +4 Sigma yesterday!!

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Bottom line – the big question is what are we in for in the near future ??

The Vol will come back to the norm very rapidly. It always does. In my book, this was a China event. In the long run, it is good for all of us, as painful as the next few days may be, as Chinese financial systems enter 20th Century by western standards.

US Economy is strong, liquidity is ample, and thanks to Secretary of Treasury and former Chairman/CEO of Goldman Sachs Group, Hank Paulson, we have a rejuvenated PPT and as Uncle Ben testified this am, “the Working Group is monitoring the markets very closely.” Once we go thru the vol retest and the forgetting rate kicks in our collective brains, we will resume the “normal course” again. A Six-Sigma Event is never normal.

In the near future, the Inflation, Gold and Crude Oil will come back. So would be the Stocks and the ETFs. We just have to work this hemorrhage out of our system.

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One of our professional traders was quoted today in Wall Street Journal's Market Beat Blog on using our Dollar-Weighted Put/Call Ratios to get short last Thursday. Click here for more details:

http://blogs.wsj.com/marketbeat/2007/02/28/better-lucky-than-long/

Volatility Revisited

Sally Limantour

The wave of risk aversion for most global equities finally broke yesterday as
rumors of a government crackdown in China on buying stocks with borrowed money and other dubious practices took hold. In our own backyard the continued concerns of higher margin debt, sub prime mortgage loans and geopolitical concerns now conspired to create fear. Up until today markets were so complacent that financial market contagion appeared to be a thing of the past. This complacency could be seen in the extraordinary absence of volatility that has been a defining feature of financial markets.
I wrote about this on 02/07/2007 stating that I was initiating long volatility strategies.

With stocks markets down sharply and exacerbated by problems calculating the DJIA index, stocks had one of its worse days in history falling over 540 points around 3:00 pm. Not all charts were plummeting however as the VIX, the CBOE volatility index shot up like a rocket closing up 64.22%. This was an unusual spike as looking back since the VIX was first introduced in 1993 there have been only 4 days in which the VIX spiked up 30% or more. It is interesting to note that the VIX has not made a 40% move to the upside since February 2, 1994 when the Fed shocked the market with its decision to raise interest rates.

This dramatic move up in the VIX still has the index at relatively low levels. Consider past events - in March 2003 when people thought the insurance sector was about to implode the VIX traded above 30. During the summer of 2002 when the telecom sector was threatening the VIX traded above 40.

So the question now is with the VIX closing at 18.31 does this mean the index is heading higher and stocks lower? Currently we are moving up from very low levels in the VIX so the percentage move up in one day is extreme. Markets revert to the mean (each way) so I would expect a short covering rally in stocks and a correction in the VIX back to lower levels in the short term. Typically VIX spikes last for a day and retrace on the second day.

Going forward, given that the market’s persistent and long running appetite for risk I expect volatility to trend higher and stocks lower in the weeks ahead. Also, my global volatility indicator that measures over a hundred global financial assets still remains at a low level and is far from signaling a buy on global stock markets. As mentioned on the post here on 2/12/07 (S&P and Currencies) my medium and long term model were warning of a “high wave risk aversion” (meaning a sell signal) and I was concerned about the unwinding of the carry trade and mentioned “we could see a bear trap rally in the yen.” All of this could lead to what was referred to in a FT article, “The Great Unwind is Coming.”

I will add that with the creative financial engineering we have witnessed leading to highly leveraged derivative strategies it is difficult to assess where real liquidity begins and leverage ends. This is something we will find out in the weeks ahead.

Volatility

Sally Limantour
February 8, 2007

Volatility or the lack of is on everyone’s mind. On CNBC early this morning they played the theme song from Jaws with the title, IS VOLATILITY COMING BACK – then phased out to a commercial. The NYT on Feb 3rd had an article IT’S CALM. LOOK OUT FOR A STORM. “If complacency breeds danger, then we might be sitting on a powder keg heading into 2007,” James Stack, editor of, Invest Tech Market Analyst.

The low reading in volatility which is trading close to record lows set in 1994 is comforting to many. A belief that the evolution of financial products makes the stock market inherently less volatile than it use to be is becoming its own mantra.

“People are very worried about risk,” says Tobias Levkovich, equity strategist at Citigroup Investment Research, and the fact that so many investors are focusing attention on volatility is another reason not to be concerned.

I see the logic in all of this – being concerned, not being concerned, being indifferent about being concerned all over this concept of volatility. My gut feel is this is going to be a volatile year. I have my reasons why and began putting on volatility strategies last week. We shall see…

Bonds

Dr. Plosser tried to crash the party yesterday with talk of higher rates. At the heart of his antinflationary remarks is a fear that labor costs are about to advance. The market remains well bid and shorts established two weeks ago were covered yesterday. Perhaps a light upward bias will take bonds back to 112 00, though I would be a seller there. You have a sector of the trade questioning overall growth prospects ahead and then you have the non-farm productivity up 3.0% annual rate in 4th quarter which was far better than the consensus of 2.0% (non-farm payrolls for all of 2006 rose 2.1%).

Stock Indexes

HSBC has warned that debts will be higher than the consensus due to further deterioration in third-party originated sub-prime mortgages in the US. Disney had impressive earnings and while I think we are building toward a correction you cannot argue with the pretty charts. The mid-cap and small caps are leading the market and that is usually a positive development. The NASDAQ is the only major index that has not set a new high this month. February typically is one of the worst performers, but seasonal tendencies cannot always be trusted nor followed. Trade with caution and perhaps tighten the stops.