All hell seemed to break lose last week, as the S&P recorded it’s worst week since the GFC back in 2008. Volatility Index (VIX) closes at its highest level since August 2015, catching many inexperienced investors by surprise.
All hell seemed to break lose last week, as the S&P recorded it’s worst week since the GFC back in 2008. Yup, that’s the worst week ever in more than a decade, which also means that the sharp and rapid drop would’ve taken most market participants by surprise. Many newbie or less experienced investors would be caught in a web of emotions (mainly fear), as this is something they’ve never experienced before.
The indices dropped ferociously every single day for the entire 5 trading days of the week, and with almost every major global index being sharply down, many investors would’ve found their fortunes severely decimated within the mere span of 5 days. DJIA dropped 12% within the week, and the 10 year treasury yields dropped to a record low, as the flight to safety came back with a vengeance. Already, globally, we are seeing negative forecasts popping up, with many forced to revise their previously, ridiculously optimistic views. Here in SG, it’s already forecast that Q1 would experience a contraction at -0.6%. So yeah, in summary, it’s not a pretty sight.
In response, the volatility index (VIX) went ballistic within the week, reaching it’s highest since 2011. With this, I’ve just initiated short positions on volatility, selling calls on VIX derivatives. In essence, the thinking behind this is not difficult to understand. Market’s fear of unknown and uncertainty grows exponentially. When we try to extrapolate our emotions further out into the future, it’s usually a poor estimate of what actually transpires. This means that when we are pessimistic, the reasons and rationale for being pessimistic are usually very much true in the short term, but further out, they tend to be overly pessimistic.
Yannis Couletsis of Credence Capital is doing something similar:
“The director at Credence Capital, the volatility-trading arm of KM Cube Asset Management with 150 million euros ($164.2 million) under management, is betting that the fear gripping global markets will prove short-lived. He’s selling options to anxious investors who have sent the price of the derivatives soaring in an attempt to shield themselves from further pain.”
“The logic behind the strategy is received wisdom among derivatives traders but a puzzle to the uninitiated. It’s known as the volatility-risk premium, or the tendency of investors to demand higher compensation for future uncertainty compared with what actually comes to pass.”
““We are confident in our system’s signals,” he said. “Volatility is mean-reverting in nature. All our indicators signalling short-vol positions are still on.””
Only difference is that TTI is not so heroic to put 65% of my portfolio to work doing this. It’s going to be a very reasonably small position. As long as the indices don’t drop to another 12% within the next week, I’d be alright. Premiums for all puts have obviously gone ballistic in the past week, and accordingly, the premiums for VIX derivatives have gone ballistic as well. Shorting VIX derivatives with costly, very much expensive puts is a fool’s game to me, so shorting naked calls is the way to go.
Aside from the erosion of time premiums being a MOS, I’m betting that we don’t experience yet another 15% decline in the next week, and another 15% decline in the week after. Coz after all, nothing goes down in a straight line. (except in cases of fraud)
I’d also state that in the midst of all this fear, I’ve already started adding to long positions, as per the plan previously:
New, trial portfolio is down YTD, just like the main portfolio, and probably just like almost everyone else, but I’m optimistic as some parameters that I’m tracking are looking strong.
Thanks for reading.
Once again, this article is a guest post and was originally posted on ThumbTackInvestor‘s profile on InvestingNote.
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