The range has been huge and the VIX futures are telling us it might not be over. Last Saturday I said that I wouldn’t be surprised to see a gap lower or a gap higher this Monday. We saw a big gap lower followed by a deep push down. That push lower was followed by a strong push higher that left the markets slightly up on the week.
This week is a prime example of why people think timing the markets and the markets themselves are totally ridiculous. Despite the rally we saw on Thursday and Friday, the term structure of the VIX futures is still in Backwardation. What that means is that, from a volatility standpoint, we’re not out of the woods yet.
One of the things we know is that volatility increases when a market is trading below the 200 day simple moving average. It’s worth pointing out that volatility is not directional, but it does tend to increase on the downside. The daily ranges we’ve seen over the past two weeks are huge. From a trading standpoint, I’ve been moving positions quite a bit and trying to keep my size small. Check out the daily RUT chart below to see how I’ve been moving the October Butterfly. Right now, it makes sense to remain nimble and remember that more downside is still possible.
Levels of Interest:
Implied & Historical Volatility:
The image below illustrates the VIX Futures term structure (/VX if you’re on TOS). The lines are several shades of gray to show the progression that took place from last Friday. Lighter gray means the line is older and this Friday is shown in red.
In a calm market, the front month VIX Futures contract generally trades at a lower price than the subsequent months (Contango). Last Friday we had an indication that all was not well when the front month contract was trading higher than the second month (Backwardation). It’s important to point out that, despite the moves higher late in the week, the term structure has NOT changed and more downside is possible.
In order for me to feel more bullish, the curve needs to flatten, shift down, and return to Contango.
Under the hood . . .
The “Under the Hood” section of the commentary focuses on actual trades that are in the Theta Trend account.
The Iron Condors I had on last week were closed at a loss on Monday. It was not fun and I’m mostly out of Iron Condors right now. I resold a November put spread in RUT that is quite a way down and should be fine unless the market continues to crash.
$RUT October 2015 Butterfly:
This week was a challenging week for the October Butterfly. On Monday, I played chicken with the market and got uncomfortable late in the day. Rather than move the position down (the right move), I decided to carry an IWM put overnight in case there was a bigger crash on Tuesday morning. That crash never took place so I sold the put at a loss and moved the Butterfly down on Tuesday. Yesterday, I added to the position when the market traded up and through the new upside break even.
This week is a good example of why I like trading Butterflies. Despite the market flying all over the place, the position is relatively easy to manage and can be traded in a way that avoids big draw downs.
Note that while the position is down money, the majority of the loss is related to the short put. I feel very comfortable in this trade, the greeks are good, and overall the position looks healthy.
Looking ahead, etc.:
Who knows what happens next. The market is whipping all over the place right now and we’ve made a big run in the past couple of days. I’m beyond issuing an opinion on direction, but the volatility environment is saying that things could still get ugly. If we see the VIX Futures flatten out, fall, and return to Contango, I just might feel a little bullish. Until then, we’ll see . . .
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