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Cognitive Dissonance
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Cognitive Dissonance

by The MoleDecember 18, 2011

Right out of Wikipedia: Cognitive Dissonance is a discomfort caused by holding conflicting cognitions (e.g., ideas, beliefs, values, emotional reactions) simultaneously.In a state of dissonance, people may feel surprise, dread, guilt, anger, or embarrassment.

When looking at my usual suspects this weekend I could not help but feel a bit of cognitive dissonance of the confused kind. A lot of things just don’t make sense right now and you don’t have to be a seasoned trader to sense that something’s rotten in the state of Denmark. For starters – we should be climbing up right now – not gyrating around the 1200 mark – what ever happened to our Santa Rally? Let’s try to make sense out of what the charts are telling us right now.

This will be our core chart for today’s post – as the general confusion I sense is reflected in volatility. If you are a sub then you have seen this chart a few times in the recent past. We are looking at volatility ratios and the name of the game is to pick up divergences against the SPX as well as against each respective ratio. In case you are a noob or simply forgot what each symbol represents then you are in luck as I have provided rough summaries on the SPX panel. Subscribers may refresh their memories via my ‘Volatility For Dummies‘ post I put together earlier this year.

Alright – if you are not used to ratio (or FX) charts then this may be a good mental guideline: The first symbol is the dominating one – meaning if the signal line pushes up it is gaining against the second symbol. Ergo the second symbol moves inverse to the ratio – if the line drops then it is gaining, if it climbs then it is losing.

Now let’s review these respective ratios and then try to make sense out of what they are telling us:
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More charts and cynical commentary below for anyone donning a secret decoder ring. If you are interested in becoming a Gold member then don’t waste time and sign up here. And if you are a Zero or Geronimo subscriber it includes access to all Gold posts, so you actually get double the bang for your buck.
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First up I want to point out that this are not really ratio charts – I am actually deducting one symbol from the other. But after comparing ratio with delta charts I felt that they are pretty much telling us the same story, so let’s just pretend these are ratios we are talking about. Let’s go:

VIX-VXO: We are comparing front month IV across all strikes against only front month ATM IV. That’s pretty basic – how much are you paying for ATM strike IV when compared with the average of all front month strikes. Got it? What’s immediately apparent is that this signal line has been dropping which means that the second symbol is gaining against the first. Which again means that option buyers are paying increasingly more for ATM strike vega than they are paying for option vega across all strikes on average. In my experience this usually happens ahead of large short term moves as option sellers are expecting short term volatility in one direction or the other (usually it is against the current medium term trend, but you can’t always count on that – consider your medium term momentum or sentiment charts first).

VXV-VIX: Here we are comparing all quarter (i.e. all strikes within three months) IV against all front month IV on average. Basically a direct comparison of front month vs. quarter implied volatility. And that line has been pushing up pretty high – which means that front month IV seems to be dropping (i.e. getting cheaper), at least when compared with quarter IV. So on a three month basis it seems that option sellers are expecting more medium term movement and are protecting themselves accordingly. Perhaps a medium term trend change?

SKEW-VIX: Finally we are comparing front month OTM put/call IV delta (i.e. the cost differential between equal distance strike OTM puts vs. calls) with regular front month IV average. I know this is a bit of a mind bender. Just imagine you compare the premium of a call five strikes out with a put five strikes out – simple right? If you are paying a lot more for that put then that may be a first hint that market makers are expecting some down tape.

Of course in our case the delta between those two doesn’t tell us much about the direction but when comparing it with regular vanilla front month IV (i.e. the VIX) then we at least know whether or not option buyers are paying more for at least one side of the OTM put/call delta than they are coughing up for let’s say ITM or ATM strikes. You can then go further down that rabbit hole by doing some IV put/call comparison in for instance ThinkOrSwim but that is out of the scope of today’s post. What’s important to us is that it’s rising and that means that there is increasing SKEW when compared with Mr. VIX. Thus it would not be unreasonable to assume that we may see some OTM strikes being touched in the not so distant future.

Of course sort of ties into that VIX-VXO chart, which suggests that we are going to see some short term volatility. The fact that there is an increasing delta on the SKEW side (i.e. OTM put/call IV) tells us that one side is more heavily favored than the other. Now let’s figure out which side market makers are pricing more heavily:

If you happen to trade with ThinkOrSwim then you can easily put this chart together yourself – just go to the tools tab. Anyway, this is very interesting to say the least: Obviously there is really no volatility smile anymore – in the past few decades we had several crashes and it’s more of a volatility decline now.

Okay, per the above let’s now look at OTM strikes: As the current strike is 122 it’s fair to compare the 124 call with the 120 put. January shows us around 22% for the 124 call and 24% for the 120 put – not too far apart and that delta is pretty common. The same applies for February, March, and April. What however strikes my interest is the difference of the February (i.e. red) line between the put and call panel – obviously it’s much more distant from March on the put side than it is on the call side.

A word to the wise – when pricing OTM options we as buyers really have to think ahead. Which means that if you expect to sell your puts or calls OTM then you don’t want to do it during the front month – you want to do it at least 30 days ahead. So given the above this affects January a lot more than it does February as you would probably want to sell those options back in January unless you expect them to be ITM. Trust me – a lot of people have gone broke buying OTM options – but again that’s a story for another day.

Bottom line here is that put IV for Jan/Feb seems to be cheaper than call IV – and hence the title of this post as January is usually a bad month for the bulls (except maybe the first week). In any case we should however expect some short term fireworks as well as some medium term fireworks – how fun!

Supporting my general theme here on one hand is Mr. VIX which has been dropping – along with equities. Plus we don’t see a close outside the BB, which is now dropping along and rather steeply. All of which is bad for the bears – so perhaps MMs are looking the right way short and medium term?

My magic MMMR1 however is in a strange configuration – we should be dropping down here and I have not seen it push higher and higher while the SPX was dropping. In the first few days I thought this merely meant more downside – and I was right. However, at this point I do not know how to interpret this chart properly and in particular with how options are being priced right now.

Here is the MMR2 – very same story. I tried to line up the SPX with the first one and it’s not exactly correct – for some reason there are spacing differences between those two. Why does Prophet chart sucks so bad on one end but does some things so well? In any case – give the correlations some leeway and just focus on the fact that the current one has almost no precedence.

And here’s only the MMMR3 panel – same story.

Meanwhile copper is barely hanging on to its PBO of 4.35 – if it drops below 3.25 that’ll flip the other way. Usually copper leads equities so this flies in the face of what MMs are pricing on the equity option side.

They did however predict movement and ole’ bucky seems to agree. As we expected the first leg of the short squeeze came a long way quickly and thus a little correction was to be expected. However, medium term I think we’re going quite a bit higher as promised by that inverse H&S plus the BPO of 83.3. Although not officially on the menu I am thinking Long Tail Up Reversal here on a short term basis, which would be the inverse of the Long Tail Down Reversal – thus being a sell signal. Thus – Dollar short term: a bit more downside. Dollar medium term: more upside if that BPO (and the inverse H&S) play out.

All in all we have a lot of contradicting evidence here and for the remainder of this month I will keep my trades very nimble and most likely limited to playing intra-day swings (i.e. Zero or ZeroFX) mixed with the occasional FX or commodities setup. On the equities side I simply see too much cognitive dissonance to really feel comfortable risking any significant coin on betting on a particular direction. This will most likely sort itself out in early January when the big dogs are back at their trading desks.

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Public Service Announcement: I have an early Christmas gift to reward all you well behaved Zero subs – over the weekend I implemented the ZeroFX spike alert notification system and even tested it earlier today.

This is the email I received:

Extreme signal condition detected on 5-Minute EURUSD panel:

White momentum signal UP spike to 3.77 – possible buying momentum exhaustion!
Blue participation signal UP spike to 1.9 – possible buying participation exhaustion!

ZeroFX Live Feed: http://evilspeculator.com/?page_id=20376
Disclaimer: http://tinyurl.com/dsclmr

Everything seems to be working as expected and thus I decided to turn it on for everyone. Please make sure to have alerts [at] evilspeculator.com in your contact list. Merry Christmas and enjoy! :-)

Cheers,


About The Author
The Mole
Mole created Evil Speculator amidst the chaos of the financial crisis in early August of 2008. His vision for Evil Speculator is a refuge of reason, hands-on trading knowledge, and inspiration for traders of all ages and stripes. You can follow him and his nefarious schemes at various social media waterholes below.
  • TwinTurboRX7

    Hmmm ZFX looks different…instead of looking at the bottom, now we look at the top one for equities…

  • http://practicalt.blogspot.com/ Gold_Gerb

    AUD/JPY 5m
    some swinging, did some market just open up?

  • Anonymous

    so it’s up/down/no idea ? next move..

  • Anonymous

    Nope a lunatic passed away!

  • Anonymous

    way too much bad news. I am betting on up! Unless we crash…

  • http://practicalt.blogspot.com/ Gold_Gerb
  • Anonymous

    haha. USD jumps when a jackass dies. hmmmm

  • Joe_Jones

    jackass? the History subject was not your strength, isn’t it?

  • Joe_Jones
  • Anonymous

    JPY looking weak

  • http://evilspeculator.com molecool

    Yes, I stacked it differently – AUD/JPY first, then the EUR/USD, then cable on the bottom.

  • Joe_Jones

    now where does this go again?

  • Anonymous

    Mole – why is the 60min on AUD/JPY stuck @ 77.75?

  • Anonymous

    ok..

  • Anonymous

    Don’t like the action on the EUR at the moment. Should have started a rally, especially with the record bearish sentiment. If the low is broken, this would be an extremely bearish sign. If it holds, we may see a nice RTV buy setup for a juicy short squeeze..

  • Anonymous

    ST targets:

    /ES test 1198
    /GC – 1567  (showing weakness)
    /HG – 2.95  (showing weakness)
    /CL – 85
    AUD/JPY – 77.2

  • http://evilspeculator.com molecool

    I’ll do a post on all those tomorrow.

  • Anonymous

    Sweet!

  • Anonymous

    Great call on going short on the aud/jpy before.

  • Anonymous

    No brainer, especially with all three pairs correlated. Could of short all thee:) That tells me one thing – dollar up!

  • Anonymous

    OK – looks to be working again.

  • Anonymous

    First session HSI -2.62%

  • http://evilspeculator.com molecool

    Skynard – any thoughts on the volatility stuff I posted?

  • Joe_Jones

    I hope this post brings back BobbyLow

  • Anonymous

    Think you hit it on the head! The recent volatility action is reflective of everything you have explained:) Complacency!

  • http://evilspeculator.com molecool

    To be honest – I wrote all this down in order to make sense out of it for myself. But it still leaves me a bit uneasy to say the last. Well, you know which way the DZ is swinging – so let’s hope that one is correct.

  • Joe_Jones

    hope?

  • Anonymous

    Don’t count waves any longer, by the looks of the unsuspecting nature of this move it could be a biggy!

  • Anonymous

    IMO, if 1200 fails next stop 1190

  • http://evilspeculator.com molecool

    Subs – I just sent out an email to everyone.

  • http://evilspeculator.com molecool

    Guilty as charged – what was I thinking?? 😉

  • http://evilspeculator.com molecool

    Someone wrote me about it and I reloaded the data. Due to all the coding and configuration changes I had to reload the charts a few times. Sometimes this affects the feed as I’m loading a LOT of data to run ZeroFX. Each panel takes about one minute to load – just to give you a rough idea of the complexity.

  • Joe_Jones

    It happens to the best. Hehe!

  • Anonymous

    Just ran stops on /GC & /HG, the down trend should resume.

  • Anonymous

     Thanks for the new alerts.

    Also, zerofx is stuck as of 12:57 AM EST

  • Anonymous

    Gotcha!

  • Anonymous

    @ mole, interest to subs zero, but newbie , 

  • Anonymous

    should have an advance background to understand zero ?? 
    tia.

  • Joe_Jones

    no. 

  • Anonymous

    Thanks Mole!  Interesting charts for sure.  Looking forward to the new alert.

  • Anonymous

    Think we know where this is going:) See if we fill the gap.

  • http://practicalt.blogspot.com/ Gold_Gerb

    AMC,
    what I was talking about last night.
    I read the book from welles wilder new concepts over the weekend.

    http://i43.tinypic.com/20iuatu.png

  • Joe_Jones

    Now that the silly hour is over, we can play again.

  • Anonymous

    GG, your post. (flipping through pages of back woods slang) I think I know what you mean by she is dead. Do you mean the action is dead? Or are you implying something else. EDIT: is anyone else having issues with ThinkorSwim I would really like to know how SPX is doing anyone provide a chart I have a position in it currently.

  • Anonymous

    Added puts at VWAP test.

  • http://practicalt.blogspot.com/ Gold_Gerb

    action is dead.  no volatility.
    could because it’s a holiday week.

    http://marketvolume.com/technicalanalysis/atr.asp

  • Joe_Jones

    LOL. The background is killing me.
    😀

  • Anonymous

    thanks JJ , 

  • rhae

    SPY 10m… It is what it is, until it isn’t…
    http://screencast.com/t/gbtgORwndaBW

  • Joe_Jones

    Glad that we stopped fucking around. This was getting pathetic.

  • http://evilspeculator.com molecool

    I’m going to write a more comprehensive tutorial over Christmas. What do you need in the interim?

  • Anonymous

    Damn! Cliff diver:)

  • Anonymous

    This is one of those times when I have to remind myself about pigs and hogs!
    (covered my short /ES with three points of profit just before it dove off the cliff for four more…) 

  • http://practicalt.blogspot.com/ Gold_Gerb

    Bollinger Band constricted, check.
    Price under averages, check.
    Sto’s in Bear territory, check.
    Everyone waiting for Xmas rally, check.
    BadGuy dead, check.

    it’s too perfect.  taking the day off.

    http://i40.tinypic.com/2e1rax1.png

  • Anonymous

    hourly?

  • http://practicalt.blogspot.com/ Gold_Gerb

    2hr candles.

  • Anonymous

    thanks. 
    may be a good day to just chill, 
    enjoy

  • Anonymous

    Looks like a bear flag 5 min, waiting for 1198 test:)

  • Anonymous

    currently negative 1 pip with the eur/jpy position.

  • Anonymous

    GG I downloaded that pdf. AS in new concepts. The article was written in 70s right?

  • Anonymous

    yep Euro holding well at that 1.30 

  • Anonymous

    Good calls my man. I am still having some longs. Lets see if the Euro can hold it here and bounce back.

  • Anonymous

    lowest tick so far today 5 minutes ago,
    also liking that hourly BB range support area 
    1199 +/-

  • Anonymous

    http://content.screencast.com/users/AMCabrera/folders/Jing/media/88c252ad-b335-4ef9-ad5c-8397eff69764/2011-12-19_1153.png
    this bad boy does not even try to give hope of recovery. The only thing that does provide is it “LOOKS” oversold.

  • Anonymous

    Do you think we’ll touch 1198, or just get close? I see support on a 15 min 100 SMA lower BB at 1202, and hourly at 1198.

  • Anonymous

    I do not like the tone and wording my boy Draghi is using. 

  • Anonymous

    Dumped 1/2 puts and will reload @ 1210:)

  • Anonymous

    Yeah. Hes pretty sober. Did you hear the guy from BOE? He said now its worse than 2008! With comments like these from central banks who needs bears?

  • Anonymous

    5 min diverging, waiting to reenter.

  • Anonymous

    I would be wary however. Nuclear option will be used. Of course a waste land for trading will be left.

  • Joe_Jones

    It’s all well planned. The only thing that can save bulls right now is more QE. That won’t happen at the current market level.

  • Anonymous

    All pretty negative on the Board today.  I see a bit of a positive divergence forming on the zero.  In the spirit of quick and nimble, in for a good time not a long time etc., took a gentle plunge long with a reasonably tight stop.  Otherwise, I am too choked with grief at the passing of the Dear Leader to pay much attention today… :)

  • Anonymous

    JJ I dont know if you read a piece by S&P a week ago or so. But in summary they stated that it would take another financial crisis to get EU authorities moving faster to a real solution. In my book that is called extortion.

  • Anonymous

    The thing that bothers me is that most people seem to think exactly that. The lack of a Santa rally has sparked a lot of doom and gloom talk. I’m not saying we won’t be seeing a big plunge in the near future (I don’t know what will happen), but all of this negative sentiment bothers me a lot in regard to the bearish case.

  • Joe_Jones

    EU was built through crisis.

  • Joe_Jones

    AAII sentiment survey was quite bullish last week. Usually CBs are bullish. When they are not, there is a plan afoot.

  • Anonymous

    10ma SPX coming in @ 1214

  • Anonymous

    Food For Thought

    Market not responding to Bullish Opportunities yet the bears seem to be taking their time as well.  Could be we are marking time into the next Bradley Date which is Christmas Eve.  I’m thinking a beautiful rally starts then to help setting up some sweet bear trades down the road and perhaps a final leg in the Bond Bull.  Watching the TBT Leaps

  • Joe_Jones

    Me thinks we rally after Christmas when volume is dead.

  • Anonymous

    F**King awesome response JJ! (looking for way to click like 20x)

  • Joe_Jones

    hehehe!
    😉

  • Anonymous

    Waiting out the chop to go short again @ 1500 hrs:) Of coarse, that could be it already. 

    Yep, one more swing high.

  • Anonymous

    Close enough for me, added short:)

  • Anonymous

    Lots of BOOZE!!

  • Anonymous

    WTH, maybe see 1198 after all.

  • Fibz

    Yea, they’ll print eventually. The rest of the world will squeeze all they can out of the EU.

  • Anonymous

    MWAH!

  • http://evilspeculator.com molecool

    ¤ø„¸¸„ø¤º°¨¤ø„¸¸„ø¤º°¨ 
    ¨°º¤ø„¸  N E W  „ø¤º°¨ 
    ¸„ø¤º°¨ P O S T “°º¤ø„¸
    ¸„ø¤º°¨¤ø„¸¸„ø¤º°º¤ø„¸

  • http://evilspeculator.com molecool

    Yeah, I myself burned a candle for him today – by strapping it to a firecracker :-)

  • http://evilspeculator.com molecool

    Extortion is the name of the game now. Read this article:

    http://www.counterpunch.org/2011/12/09/europe%E2%80%99s-deadly-transition-from-social-democracy-to-oligarchy/

    Originally this was posted in the German FAZ, which is in importance what the NYT used to be here in the U.S.

  • Joe_Jones

    pin-ups

  • Anonymous

    sweet read Mole thanks!