ARCHIVED COMMENTARY
Low Volatility
Ripe for a Buy?
For edition of August 15, 2006
Mark Klizas is a trader, a seasoned technician and former colleague of mine from the floor of the Pacific Stock Exchange. Below, he shares some observations concerning the Volatility Index (VIX) that could open the door for us as traders. Mark thinks volatility is a buy at these levels, and here’s why:
“[Rick’s Picks] readers have been kept well informed of the significant risks in the economy, the world situation and the stock market. As we are about to enter the seasonally weakest time period for stocks, traders are looking for strategies to capture the opportunities of these tumultuous times. The most tempting strategy to maximize profit in a sharp market decline is to buy puts on equities or derivative products. The problem with a naked put strategy is that one has to be very good with timing as well as direction, or it can become quite costly. There is a relatively new product, options and futures on the CBOE volatility index (VIX), that could provide similar profit potential, but with considerably less risk from adverse timing and price action.
Portfolio Insurance
“The VIX has been around for many years as an information tool. It is often looked at as a barometer of the cost of portfolio insurance. It trades low during periods of complacency and high when market risk is perceived as being elevated. It used to measure the implied volatility of a representative basket of options in the OEX. The CBOE recently retooled the VIX to measure the implied volatility of near term (one and two month out) option series in the S&P 500 index (SPX). VIX futures were introduced in 2004 and cash settled options began trading in February 2006. Traders now have a direct way of trading the implied volatility in the market. I believe the recent, near historic, lows registered in the VIX near the 10 level will not be seen again for some time. The increasing intraday volatility we have witnessed of late should soon translate into the daily and weekly charts and move the VIX upward. A significant market correction this fall, a likely occurrence in my view, should accelerate the process.
“As you can see from the following chart of the VXO (the old OEX based VIX used for older historical data), the VIX has a very strong inverse correlation to the direction of stocks.
“During the recent 8% drop in the SPX, the VIX more than doubled from around 11 to just shy of 24. In fact, over the past decade, the VIX has spiked up [during market declines] by 10 or more points on 24 occasions. Eight of those spikes exceeded 20 points and 5 times they exceeded 30 points. It doesn’t take much imagination to see the profit potential of getting long this index in the teens if we are in the early stages of increasing market volatility. The stage is set for an increase in base VIX levels toward historical norms in the 20’s with spikes into the 30’s or higher in the not too distant future.
Clues from1990s
“What will happen to the VIX if the market continues to rally from these levels? A look at the chart from the mid 1990’s provides some clues. After a year of steady gains in 1995 without a single significant correction the VIX ended the year near its low around 10. The market continued to rally over the next several years, but with occasional corrections along the way. These were the “irrational exuberance” years that Alan Greenspan warned about, and the VIX chart echoed those concerns as each successive VIX rally (market correction) was met by a higher base that reached the 20 level by 1998. The recent action in 2006 looks similar to the break off the base in 1996. Could market participants be expressing their concerns by raising insurance premiums against equity purchases. While a market decline would be most profitable for a long VIX position, a market rally poses less risk than a similar short market position in equity-based futures or options.
“VIX options are European exercise (they cannot be exercised early), and therefore often trade at a discount to parity at times of market spikes. One must understand this and be willing to sell deep in the money calls at a discount to lock in profits at panic bottoms. They also offer the opportunity to purchase discounted calls part way through a big market move. Expirations are on the Wednesday before or after the traditional options expiration, depending on the month.
Autumn Risk
“Even if one does not trade the VIX, the pricing of the options relative to the underlying index can provide useful clues to market sentiment. During the market decline in mid June, the near term VIX calls were deeply discounted until right before the market bottom when they bid them up to near parity. The discount to parity must have looked enticing to those who came late to the party. As usual, that’s about the time the music stops. Currently, the November calls are well bid, indicating others are concerned about market risk going into the fall. The October calls will be listed when the august series expires and should be less pricey, but should still provide coverage for most of the fall volatility season. Happy trading.”
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San Francisco Seminar
I’ll be in San Francisco next week, finalizing plans for the upcoming Hidden Pivot Seminar. A specific date has not yet been set, but it now looks like the two-day class will be held in mid-November. If you’re interested and haven’t contacted me yet, please let me know via-email . Is this seminar for you? Here’s a prospectus so that you can decide for yourself:
Trust Yourself,
Not Some Guru
Would you like to be able to forecast trends and price swings so accurately that you’ll never again have to seek advice from the supposed experts? That is the goal of the Hidden-Pivot Seminar: to teach you to read the markets so confidently that you will come to trust your own judgment over that of gurus who forecast for a living.
My proprietary Hidden-Pivot Method derives from a few simple principles that I’ve developed and honed over the last twelve years. It is the simplest and most powerful method I have ever found for predicting trends and price swings accurately and with complete confidence. Moreover, it works in any time frame and for virtually all types of securities, including stocks, indexes, commodities and options.
Inhale…Exhale
The system is based on the theory that stocks and commodities are constantly trying to balance yin and yang energy as they move around. Their ups and downs are analogous to breathing in and breathing out, and in the end these complementary actions must offset each other precisely. The trick to understanding how the process works in the securities markets is to visually match up trend segments that are part of ABCD patterns on charts.
Consider as an example the chart of eBay below. The key number is 28.89, the presumptive D target of a pattern defined by points A, B and C. The target is what I call a “hidden pivot,” and it is calculated by subtracting the length of the A-B segment (3.90) from point C. In the example, the resulting value is 28.89, a mere two cents from where eBay actually turned. In retrospect, we see that this would have been an excellent spot to buy the stock using a stop-loss as tight as a nickel. It also would have provided a precise target to enable disciplined short-covering.
A Simple Trick
The visual trick to identifying these patterns is really no trick at all. You simply find the B-C leg first, then move backwards to locate A. Those three price points are all you will need to calculate a D target. Note that the B-C leg is simply any countertrend move that looks like it might eventually be the axis of symmetry dividing an AB impulse leg from a CD follow-through leg.
That’s all there is to it. Since the system is based entirely on price action, you won’t ever have to consider trading volume, oscillators, channels, MACDs, trendlines or any of the other conventional indicators that most technicians use. And with just one more trick, you will be capable of forecasting as accurately as those who do it for a living. You need only locate the exact midpoint of the B-C segment’s second leg. Once you are able to find this specially endowed hidden pivot – a simple task for the trained eye – you will never again need an “expert” to tell you what a stock, index or commodity is likely to do next.
The Hidden Pivot Seminar is held over two days, during which time you will learn how to spot the most promising ABCD patterns. You will also learn, in under 20 minutes, a surprisingly easy way to use stochastic indicators and other oscillators to enhance your timing. Finally, you will learn how to use hidden pivots to manage risk so that you will always know exactly when to cut losses and when to let profits run.
Free Mentoring
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An important feature of the seminar, at no extra cost, is post-grad mentoring in a hidden-pivot chat room set up by some of my students. Here is what one of them, Hunter Reynolds, recently had to say: "We have all come a long way. I think everyone here is making a little $$, or we would be doing something else by now. I can honestly say I am up about ten percent, maybe a little more, since your class. I am pretty conservative. I just trade from the long side, but I'm getting really good at picking the hidden-pivot reversal points for the uptrend!"
I should tell you that seminar grads who frequent the chat room are coming to understand my method as well as I do. Indeed, some have adapted what they learned in highly effective ways that I could not have foreseen. Buttressed by the continuing lessons of the chat-room, the Hidden Pivot Seminar offers an opportunity to acquire powerful analytical tools that will serve you for a lifetime.
A Student’s Experience
Here is what one of my grads, Hunter Reynolds, had to say recently about the chat room:
"We have all come a long way. I think everyone here is making a little $$, or we would be doing something else by now. I can honestly say I am up about ten percent, maybe a little more, since your class. I am pretty conservative. I just trade from the long side, but I'm getting really good at picking the hidden-pivot reversal points for the uptrend!"
Dates are not yet firm for a fourth seminar to be held in Sydney, Australia, but it looks like it will take place either in November 2006 or February 2007. The class is filling up, so do let me know soon if you’d like to attend.
