Play the Players

The VIX index, a measure of anticipated market VOLATILITY or UNCERTAINTY, gets labeled the “fear index” and appears to jump around almost erratically.

Unless you are skilled in options trading, the VIX may only be a curiosity.

Now there are both VIX futures (CBOE/FCE) and a VIX-related ETN (VXX) available to play with. Don Fishback has just written a very good Graham&Dodd analysis of the VXX at Seeking Alpha that should discourage anyone from exploring that ETN with real money.

Especially those who learned that, no matter how smart you think you are, investing in things you don’t really understand can be detrimental to everyone’s economy, including yours.

What is not often recognized by casual observers is that the VIX itself has options that can be traded. Skilled options traders usually employ them to get big leverage advantages when they are convinced a directional play in the market is at hand.

The VIX tends to be a contra indicator, being low when markets have built up strong advances and everything looks too good to go wrong … go wrong … go wrong, and then jumps up high when it does and no one seems to know where the bottom will be.

For a long time the VIX seemed to range over a span of 10 at the low end to 40 at its tops, with 20 or so sort of a central tendency. But then came last year’s September Crisis and the VIX rocketed to 80.

As things struggled to get back to normal the VIX hovered between 40 and 60 until the notion became accepted that perhaps a bottom had been reached in March. Since then the VIX has gradually been working its way down to between 20 and 40.

But as that has been going on, and particularly of late, the market has been undergoing short spasms of decline and recovery. One currently is in progress. The last 4 days has seen the VIX jump from 20 to 28, a 40% advance. Some VIX options are up +100% or more. The S&P500, or SPX, has declined by -4 1/2%.

Wouldn’t it be great to know when to get aboard that kind of a ride?

This is speculation, not investing. But because there seems always to be an appetite for such gambles, I’ll let you in on what we find in looking at how the options pro traders are behaving.

The analysis is the same as what we use to identify the expectations of the big volume market makers in stocks. Here the players are a different bunch, with very different tempraments and behavior limits. But they are driven to operate from the same set of logical rules while seeking low-risk, high-probability profits.

The accompanying chart shows what the options pros must believe could (not will) happen to the VIX’s price in the near future — two weeks to two months. The green days are where the expectations range is virtually all higher than the heavy dots that mark the end-of-day values for the VIX.

On a short-term basis the VIX typically moves contrary to the SPX. Under the right extreme circumstances expectations for changes in the VIX can point to changes in the S&P500. Here is a picture of how nearby SPX moves relate to where VIX expectations are in terms of its present price. (The VIX metric is like a stochastic, but uses our derived forecasts rather than backward-looking price history.)

Draw your own conclusions.

Recent News Market Forecasts, trading strategy

Precious metal ETF buys have less to do with the wedding season in India than they do with the US Government’s cure-all for every problem: Spend dollars that have to be printed, not gathered from taxation.

Despite the fact that it doesn’t seem to be getting either more Swine Flue vaccine on the scene or more mortgage or small business credit available, the trillion-dollar pace of deficit persists.

Perish the idea that it be called inflation, but prices of many things keep going up, including ETFs denominated in dollars.

Expectations of market-makers for ETFs holding either precious metals or stocks of companies that mine the stuff are on the rise, too. That makes several ETFs attractive, odds-on buys at this point.

Most appealing is IAU, the COMEX Gold Trust i-Shares, where volume market-makers see the potential for upside gain of over +10% in the next 3 months, compared to a downside exposure of less than one-quarter of that. Their batting average has been very good, with higher prices following forecasts like the present 78% of the time.

Silver may have an even bigger kick, with SLV, the Silver Trust i-Shares priced to provide an upside of almost +15% in that same time, at an exposure of some -6%. The scorecard here is not as overwhelming, but higher prices 71% of the time after such forecasts is not bad.

Even better odds and bigger price move potentials are present in AGQ, the Proshares Ultra Silver ETF that has (2x) leverage engineered into its holdings structure. There prices have been higher 75% of the time, given current day forecasts, and by 27%, on average. The forecast is only for 23% gains. But leverage has its downside, where the encounter could run to -10%, instead of only half as much at SLV.

The parallel ETF play to the dollar’s continuing debasement lies in TBT, whose (2x) internal leverage magnifies the short position it provides in 20-year US Treasury bonds. At a price of $47.89 its forecast of $54.37 indicates a possible gain of +13% with an exposure of only -5.5%

All of these ETFs have better Reward-to-Risk scores than 94% of the 2,000 other equity securities we cover. But don’t take too long to decide, their prices are constantly in motion.

Recent News ETF Investing

Recent responses to our first post to Seeking Alpha questioned whether Block Trader forecasts had useful predictive value. We wouldn’t have been maintaining them on a daily basis for the past decade if they didn’t.

Our principal interest is in identifying specific investment opportunities, not having market environment discussions. Still, with a backdrop of over 5 million price range forecasts, the potential for useful information exists.

But that overall equity market is subject to such a diversity of influences and changing circumstances, getting any useful handle on it is a task beyond nearly everyone, including us and our sources – who may be the best informed players in the business.

Instead, we prefer to find time-disciplined, defined-size, price swing situations in specific investments that have evidence of fairly reliable prior forecasts. We limit ourselves to time horizons that have reasonable chance to be foreseen, usually 3-6 months.

We get our forecasts from the way that market professionals protect themselves as they compete by taking necessary at-risk positions in stocks and ETFs. Their hedging activities are committed, forward-looking forecasts of what they believe can happen.

Here is a picture of how they saw prospects for XBI, the S&P Biotech SPDR, during the past two years:

In this chart the vertical lines are forecasts of prices to come, not records of prices past. The colors suggest investment traffic signals available at the time.

A simple, but useful guide is to consider the range top of a forecast as a sell target for a buy made at that date. The target should be kept specific to the buy, and not changed, despite subsequent events.

You say that’s not the way it’s done? Not what you’ve been taught?

Suppose you chose to buy the XBI in early April, 2008 at $50 because the biotech industry’s future then looked very bright. Damn! Were you smart – for a while.

Doing what you were taught, you held it for the “long term.” Maybe not so smart. Because here you are a year and a half later at $52 with only a 3% annual rate of gain.

Using the traffic signals instead, and reading rough estimates from the chart, you could have had (April’08)Buy@50-Sell@60, (October’08)Buy@50-Sell@57, (March’09)Buy@43-Sell@51 for gains of $10, $7, and $8; $25 instead of $2. And have had your capital available for other use perhaps 1/3^rd of the time.

With no sickening lose-a-third-of-your-money drops from $69 to $43.

This is shorter time horizon active investing, not day trading. You would have made three transactions in a year and a half, not an hour and a half. Holding periods averaged four months, not four hours — or four years.

The market-makers don’t want or intend to hold any position four months. But they can probably anticipate most of the price-moving conditions in the next 3 or 4 months. They just don’t know for sure when any of them might occur. So their uncertainty has to include them all, even if their positions are eliminated in 4 days.

Just try and anticipate what any company is likely to really earn in 4 years, let alone what their capital structure (number of shares) may be and what their auditors will allow them to report. And correctly guess what the market conditions will be like out there in time, and you might know what your return on investment will be.

Duplicate that effort for all of the candidates you might speculate in so that comparisons can be made, and, voila, you’re a long-term investor (?).

There’s a reason that America’s Cup sailboat skippers sail all those short tacks. That way the competition doesn’t get away from them if the wind shifts temporarily in their favor.

Our Approach ETF Investing, investment strategy