Think things are looking a little explosive? Volatility has been higher across most asset classes so far in 2016. The stock-tracking CBOE Volatility Index (VIX), for example, has been in a range between 20 and 30 over the past six weeks (figure 1). Compare that to its 17.7 average reading during 2015.
But it’s not just VIX that’s moving. A number of other VIX-like indicators have been bubbling higher as well—gold and oil among them.
Although VIX is easing from its highs, it remains in positive territory year to date. The index is up 18.8% since December. Most other volatility indexes have experienced even greater moves (see the table below).
|S&P 500 volatility||VIX||18.8%|
|NASDAQ 100 volatility||VXN||35.5%|
|Russell small-cap volatility||RVX||26.4%|
|Emerging markets volatility||VXEEM||40.3%|
|Euro currency volatility||EVZ||25.7%|
YTD data through February 18, 2016. Source: CBOE
Recent movement in the CBOE Crude Oil ETF Volatility Index (OVX) has been especially notable (see figure 2, below). OVX pushed to multi-year highs of 81.12 on February 16, its highest level since early 2009. It dropped to 67.49, or 16.8%, just two days later. Still, the index is up 44.9% so far this year. That makes it the second biggest mover behind the CBOE Gold ETF Volatility Index (GVZ). What’s driving OVX’s move? Crude has lost almost $7 this year; it hit 12-year lows of less than $29 on February 11. (It’s trading near $32.50 per barrel at the time of this writing.)
Gold’s move is interesting as well. In contrast to VIX and most other volatility indexes, GVZ is moving higher in sync with the precious metal’s price—defying the typical inverse relationship between asset prices and their related volatility measures. Gold is up nearly 17% this year, and GVZ has jumped more than 75%. Meanwhile, the CBOE Dow Jones Industrial Average Volatility Index (VXD) is up 20.6% after a 5.8% decline in the stock index.
Volatility in crude oil seems to have had broader market impact. On the one hand, the recent drop in prices has weighed on shares of energy-related companies because it adds to the earnings uncertainty for the sector. At the same time, some market watchers believe that falling energy prices are a sign of broader weakness in the global economy (China).
The rapid ascent in the oil volatility index seems to reflect those increased anxiety levels. Yet, the recent decline is possibly a sign that sentiment is improving. That’s true not just for the oil index, but also for the other volatility indicators. Well, except for the one on gold.
In its six-year history, GVZ has surged past 30 only nine times. That includes the February 11 move, when it spiked to 31.60. The all-time high of 43.51 for gold volatility was recorded in September 2011, when the underlying metal’s price peaked. Although any future move in GVZ or any other indicator is not guaranteed, we can look at some history. Those nine surges above 30 for GVZ have typically preceded a direction change in gold’s price. Will that play out once again? If so, will it be a move exclusive to gold? Or could it tell us something about the broader financial markets?
Tom White’s RED Option Strategy of the Week: Defining Risk with Calendar Spreads
Editor's Note: As of October 3, 2016, RED Option is now TradeWise.
Interested in seeking profit from range-bound markets? Want to take advantage of time decay rates in different expiration cycles? Would you like to define your risk? A long calendar spread is designed to pursue these goals.
A long calendar spread, also known as a time spread, involves two option “legs” and can be directional or neutral depending on its strike prices. It’s a strategy to consider during low-volatility environments.
Calendar spreads are composed of options in two different expiration cycles or series. The options are both calls or both puts. The calendar spread is created by buying an option in one expiration cycle and selling another option in a different expiration cycle, but with the same strike as the first option. A long call calendar spread means selling a call in a near-term or front series at a certain strike, and buying a call in a longer-term or deferred series at the same strike. A long put calendar spread means selling a put in a front cycle at a certain strike, and buying a put in a deferred month at the same strike. Both of these positions are risk defined, as the price you paid for the calendar is the amount you can potentially lose.
A short call or short put calendar spread is simply the reverse of the long calendar spread: long front series and short deferred series. The difference is that these spreads are not risk defined, because you are short the further-term option, and the long option expires first. It’s essential to keep this in mind so that you can make adjustments if you end up short the longer-term option.
Calendar spreads, whether they’re calls or puts, reach maximum value when the price of the underlying stock is at or near the strike price of the options and the front-month option is expiring. Their value decreases when the price of the underlying stock is very far away from the options’ strike price. So if you buy a calendar spread, you want the underlying stock’s price to be as close as possible to the strike price at expiration. If you sell a calendar spread, you want the underlying’s price to be far away from the strike price at expiration.
A long calendar spread might be a good choice if you think a stock’s price will approach and then stay at a particular strike price until the expiration of the front-month option. Again, the maximum risk is the amount you pay for the spread plus transaction costs; the profit potential depends on the value of the deferred-cycle option when the front option expires. The spread’s value depends on the price of the underlying, the time to expiration, and the volatility of the individual options in the trade. Ideally, the underlying should be at the strike price as close to option expiration as possible. Any increase in volatility will also expand the value on a long position, as it’s a positive vega (volatility) position. At-the-money calendar spreads have the most value, as time decay (theta) is greatest near the price of the underlying. The farther price moves away from the strike, the more value the calendar position loses.
Calendar spreads are designed to take advantage of a range-bound market, low volatility, and time decay. Of course, predicting where a stock will be at a specific time can be difficult, if not impossible, but at least you’re defining your risk. Calendar spreads can be stand-alone trades, or you can use them to hedge other positions.
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