Blue Horseshoe Loves This Finance Blog

 TWITTER Last Friday, Michael Khuow - a contributor to CNBC's 'Options Action' - posted a portfolio hedge trade on Twitter of a July VIX 25/40 call spread with a max profit-to-loss ratio of roughly 6.5x. https://twitter.com/OptionsAction/status/1380647907603451906?s=20   https://twitter.com/OptionsAction/status/1380647907603451906?s=20 Let me first say, Michael is a highly intelligent and accomplished professional whom I have a great deal of respect for and hold his opinions in high regard.  However, I happen to disagree with him on this one... VOLATILITY OF VOLATILITY Let's start by looking at the underlying in this trade because the VIX is unique.  Here's its roughly three month distribution (duration of our trade) for the last two years... Clearly, there's an extreme right-tail relative to its mode... this is to be expected and its this feature I believe Michael is trying to exploit as a hedging instrument. However, over this look-back period, the VIX was a...

HISTORICALLY OVEREXTENDED  For anyone who followed the previous blog, you're familiar with the concept of 'Market Variance.'  It's used to describe situations where price actions have moved away from a trailing average in a significant way. https://bluehorseshoefinance.blogspot.com/2018/11/market-data-analytics-variance-revisited.html Typically, my writing has focused on one day candle charts but a market variance of historic proportions has emerged in the Nasdaq monthly chart that is certainly worth taking note of.  Here's a historical Nasdaq 100 chart with monthly candles: The blue line in the chart represents the 20 period simple moving average (will now be referred to as the 20 SMA).  As of this writing, the 20 SMA is at 8927 while the Nasdaq current price is 11665... a huge nominal difference to say the least. The technical indicator previously cited, Market Variance, was built to quantify the extent to which a price varies from some appreciable mean relative t...

DELTA DOESN'T CUT IT Just a quick post about managing risk in an equity derivative portfolio. A great deal of attention is given to option Greeks when discussing risk management and rightly so.  Greeks are useful tools to delineate the risk of a singe option.  We know delta is the first derivative of the option pricing function and describes the linear change in the price of an option given a change in the underlying security... this is a good thing to know. But what happens when we structure trades using multiple options? A few months back, I wrote a piece on using vol skew to structure a bearish position on the SPY: http://tancockstradingblog.blogspot.com/2017/12/using-vol-skew-to-short-raging-bull_5.html Here, I showed how shorting mispriced options can be an effective way to structure a trade to capture market drawdowns.  The example used was to short 23 contracts of a 30 day put that was far out of the money and buy two individual puts closer to the money (the SPY wa...

BACKSTOPPED The NHL playoffs are in full swing and at this time of year a hot goaltender is often the difference between winning and losing. Hockey's history is a cautionary tale for any highly favored team to not overlook an opponent with a hot goalie: Jim Craig in the 1980 Olympics, Mike Richter in the 1996 World Cup, Ryan Miller in the 2010 Olympics (very nearly won), Jonathan Quick in the 2012 Stanley Cup playoffs. In hockey, the goalie backstops the team and is the last line of defense against an aggressive opposition. In today's equity market, the last line of defense against an aggressive breakdown has been the S&P's 200 day moving average.  Over the course of the past 29 trading days, the support level has backstopped falling markets a total of 8 times - today included. But what happens if this level fails to hold the next wave of selling?  When tested a few weeks back, the market had already expended a lot of energy just to get to that point as price level vari...

"THE SIGNS I SEE... ARE DISTURBING SIGNS" -Robert S. McNamara When asked by President Lyndon Johnson in March of 1964 about the state of affairs in Vietnam, Secretary of Defense Robert McNamara replied:       The frank answer is we don't know what is going on out there.  The signs I see coming through        the cables are disturbing signs.  It is a very uncertain period.  While I would certainly never trivialize the sacrifices made by the millions of soldiers, men, women and children in Southeast Asia during the Cold War and anti-colonial uprising, it may well be time to buckle up because the signs coming out of markets across numerous asset classes are lining up in disturbing order as well. EQUITIES Equity markets have been rocked by waves of selling that were compounded by automation, again, as short selling bots took out a leveraged inverse volatility ETN worth hundreds of millions of dollars in just a matter of hours. Whi...

"IF YOU THINK THIS IS OVER THEN YOU'RE WRONG" -Radiohead, 'Separator' Anyone who's ever inadvertently paid attention to an investment advisor commercial or bothered to read a mutual fund prospectus is familiar with the phrase, "past performance is not indicative of future results."  This is legal jargon for 'you can't sue us if we lose all your money.'  In reality, however, past performance is used ad nauseam to predict future results, especially in today's world of ubiquitous data driven models. Right now, past performance is indicating the blasts of selling and accompanying spikes in volatility in equity markets this past week do not appear to over.  Looking at past episodes of market turbulence, there are quantifiable trends that tend to indicate when a market has found its bottom.  Before we actually try to find the bottom of this market, let us first define a few key concepts of quantitative finance.  QUANTITATIVE FINANCE - 101 L...

"THE ROAD GOES ON FOREVER AND THE PARTY NEVER ENDS" -Robert Earl Keen Equity markets are enjoying one of the longest running bull markets in history right now as the S&P 500 has not had a 20% correction in (the technical definition of a bear market) since the end of the financial crisis of '08-'09.  Furthermore, since the US Presidential election of 2016, the index has yet to experience a single month of negative performance.  If this continues through December, 2017 will be the first year in the index's history to not have a single down month.  Simply put, this market is unprecedented. Given the duration and magnitude of the current rally, professional investors are beginning to voice concerns about how much stamina the bull market has left.  It seems like every day a new headline appears about the latest headwind that will ultimately break the rally; whether it's new struggles in tech stocks, the quickly-flattening yield curve, equity vol falling below f...