Volatility

I was looking for the post I put out or at least I think I put out showing the short term Volatility Futures with a substantial positive divergence where it counts. This is important because it tells us what Smart money is doing and it fits our model of what we expect and have seen them doing. Since I couldn't quickly find the post, I just recaptured the charts.

 Most of you know the VIX, most of you also know the VIX of the late 1990's and 2000 is not the same VIX of today as the index was re-worked in 2003 to allow for a broader range of input data using the S&P-500 whereas before the data used was much more limited. It's often called the "Fear Index" as a rising VIX indicates traders are more fearful, a low VIX indicates traders are complacent.

The VIX represents an estimate of 30 day forward looking S&P volatility, there are measures for the NASDAQ and Dow as well (VXN and VXD). Today's jump in the VIX represents that fear, but there's more to the story.

 A pop outside of the daily Bollinger Bands is often considered a significant event, although the bands were rather narrow the last several days.


 As you can see intraday, the VIX has seen a little move to the downside.

However what may be the most important information here is the grab for protection via Options hedging, which is one reason the VIX is higher today, this is not a new event that just occurred today as I'll show you.

If large funds have long exposure they think they can't unwind fast enough without suffering horrible fills on their orders, an alternative is to hedge those positions. A very simple example is you are long a stock that you fear may go down over the next few weeks or so, your position is so large that if you tried to sell it quickly you would put so much supply on the table that every shark watching the tape, market maker, specialist, and certainly HFTs would know what you are up and to and they would front run your order causing you to get a very low price execution. When dealing with positions that are hundreds of thousands if not millions of shares, this is a problem that we don't face or understand unless we get involved in some very low volume positions (typically under 100k shares a day) so buying a protective put to hedge downside in the stock is an option; for whatever you lose in the actual stock, you make up for in the Put, thus you are hedged, but there are many different themes and complex strategies involved and I'm just giving a very broad, simple example.

 Since I can't use 3C on the VIX intraday, only daily, I use the short term VIX Futures represented by VXX or the leveraged version, UVXY-this gives me an idea of what is going on below the surface of price.

I rolled this 15 min chart of the VXX back to yesterday's close, at the bottom right corner of the chart in the red box you can see the time and date (12/20/2012 4:00) so you can see what was going on BEFORE last night. The important thing here is the 15 min positive divergence in the VXX, this is very large, very strong, the recent lows were accumulated heavily as you can see by both a large relative positive divergence and the ;leading positive divergence, protection was cheap and it was being accumulated in a way we haven't seen recently.

Beyond that, look at the 2 hour chart of the VXX, note the general confirmation with the price trend to the left and then a huge leading positive divergence on an extremely long and important timeframe. The 2 hour chart tells us this is huge accumulation and that the highest probabilities are in the direction of this accumulation and since the VIX and VXX trade opposite the market, it implies a massive market decline which is what I have been talking about. Remember I said that I think the transition is going to be very fast from up to down, how much faster and more extreme could ES (S&P) Futures going limit down on a 50 point plunge last night actually be?

The point here being, the short term timeframes are interesting and useful for timing, for tactical positioning, to understand what's happening short term, but the longer charts are where the probabilities and big picture of what is really going on can be found. This is telling us smart money is afraid, things may be happening faster than they expected and they are apparently reaching out to try to cover their butts.