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Realized Volatility Profiles: Futures
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Realized Volatility Profiles: Futures

by The MoleApril 7, 2016

Today I will introduce an aspect of volatility that you most likely have not seen being addressed anywhere else: realized volatility profiles. First up let’s make sure you all understand what realized volatility (RV) is and how it compares to implied volatility (IV). Simply RV measures the amount and amplitude of price change observed in a financial instrument over time. Big moves to the up side and down side will both produce spikes in RV. As such the volatility we measure or predict always produces an unsigned return – it does not care whether the market goes up or down.

Implied volatility also produces an unsigned return but it works a little differently. A widely observed measure of IV in equities is the VIX, which rises when prices fall and falls when prices are on the rise. However it never even gets close to the zero mark and there are no negative readings. The reason for that are pretty simple – IV’s goal is to measure the expectation of volatility and as such rising prices are considered positive and thus less ‘volatile’ as falling prices. One could say that IV measures how investors/traders ‘feel’ about the market and what they expect will happen in the future. This also explains why you will often see the VIX fall a little after a big IV spike to the upside. Although fear most likely prevails the expectation is that the probability of more downside (in the underlying) is now more limited. As such IV is a bit of a strange beast and many traders use it on a daily basis without fully appreciating what it really represents.

As a side note: Ernie Chan recently wrote a very interesting post on his Quantitive Trading blog that suggests that on average, an increase in realized volatility due to negative returns is … accompanied by a decrease in implied volatility. I had to read this one several times to make sure I didn’t get it wrong. He does concede that a very negative return in SPY is indeed usually accompanied by an increase in implied volatility or VXX (a Barclay ETN based on the VIX)Isn’t that fascinating? On a day to day basis, outside the big moves, negative moves inside the standard deviation apparently still produce a decrease in IV 57% of the time.

I mentioned this because I want you to understand that realized RV differs from IV, and not only is it much easier to understand but is also much more predictable. Which in fact is the main theme of this and future posts on the topic. Today’s installment aims at establish a basic understanding of how I measure RV and how I use it to anticipate various RV cycles:

2016-04-07_natgas

And what better way to do that than to actually show you an example. What you are looking at above is a 60-minute chart of natgas. The reason why I use 60-min charts is because they best reflect my trading window (hours to days) and as it turns out volatility flows in relatively predictable cycles within that timeframe. The indicator in the middle is called the Mole which I rolled myself – it’s a hacked version of ATR and I simply slapped a Bollinger around it. The rest is a bit of white man magic which means fiddling with the settings to produce something meaningful.

Natgas doesn’t have the best reputation among traders, as a matter of fact we often call it the ‘widow maker’, but it does feature a very clean (realized) volatility cycle. As you can see prices flow from slow periods into fast periods. The cycles are similar in amplitude and frequency – if you would record a few months of this and hook the signal up to an oscilloscope then you would hear a relatively even and audible sound. So let’s try to produce a volatility profile for Natgas:

Natgas Realized Volatility Profile
Frequency: Regular
Amplitude: Regular
Standard Deviation: Low to Medium
Overall Noise: Low
Transition Noise: Low
Resolution Noise: Low
Velocity: Fast

When I refer to standard deviation then I talk about the delta between the slow periods and the more volatile periods. If you look at the yellow candles, which mark the point at which we expect volatility to expand, then it’s clear that most of them are pretty tiny in comparison to the big moves that follow.

Overall noise means that we’re not observing a lot of sideways whipsaw across all the entire volatility sine wave. There are occasional traps but in comparison with other futures symbols natural gas seems to be a veritable fun house for swing traders. Short term volatility swings seem to be very predictable and if you manage to get a seat on the bus you’re in for a good ride.

2016-04-07_silver

Now let me show you a contract that is difficult to trade on a short term basis as volatility swings are more random and trend phases often do not manage to get out of the gate: silver.

Silver Realized Volatility Profile
Frequency
: Irregular
Amplitude: Irregular
Standard Deviation: Large
Overall Noise: High
Transition Noise: Medium
Resolution Noise: Low
Velocity: Medium

Just looking at that volatility signal gives me shivers. Although the Mole indicator does a pretty good job at predicting volatility trying to trade it in gold would most likely result in a good number of consecutive losers. The transition noise between low and high volatility is medium (I have actually seen worse). It’s not impossible but you probably still need to employ other measures and pick your entries wisely.

2016-04-07_gold

Not surprisingly gold isn’t much better:

Gold Realized Volatility Profile
Frequency: Irregular
Amplitude: Irregular
Standard Deviation: Large
Overall Noise: High
Transition Noise: High
Resolution Noise: Low
Velocity: High

Although gold has high velocity and low resolution noise (when it moves it moves and doesn’t look back) it has one big draw back: Transition noise appears to be high. Look at the blue candles – those mark periods when volatility is on the rise but isn’t pushing above the upper standard deviation bubble yet. It regularly produces consecutive candles with large wicks within a range which is fancy speak for saying that it’s trying to kick you out of your campaign before taking off. Silver does it as well but I think gold really has it down to a science.

More profiles below for subscribers, we’ll cover wheat, crude, copper, the bonds, and of course the spoos. Please join me in the lair:

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I hope this post opened a perspective on the market that you didn’t even know existed. You can probably experiment around by yourself via the ATR indicator and get a good feel for how each contract flows. Next week I will follow up with short term charts on the Forex side and then we’ll be looking at the daily panels. So plenty of material to work through and I expect it will significantly aid you in anticipating volatility swings and thus in picking your entries moving forward.

Free Sub Available

By the way if you are interested in the Mole indicator: Subscribers are actually able to sign up for volatility alerts which are triggered near the end of the low cycle (i.e. yellow candles). It’s a free sub available on the signup page – but you need to be an existing subscriber of either Gold, the Zero, or any of the systems offered.


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.
  • ridingwaves

    Seems overall noise is key component?
    GC/SI algos might be the meanest in the world with every banker pitted against gold lovers…
    how would it look on e-mini?

  • http://evilspeculator.com Sir Mole III

    Subs know – I posted it. Hint – it’s a good contract for swing traders.

  • ZigZag

    were you going to make comments on crude? I was going to say “crude comments” but that didn’t sound right

  • ridingwaves

    gotcha…seems SPY with more liquidity would be prime for it.

  • Time Bandit

    ZigZag

    I need to say that you were absolutely correct about the API Report yesterday and I was wrong. I don’t use reports to base my trades on anyway so my saying that there was something sneaky going on Tuesday Afternoons was off base.

    I put my first Short on Crude using /QM earlier this morning so I’ll get stopped in real time now instead of getting whacked with an overnight gap. All is well. :)

  • Round we go

    awesome post mole. i love the bullshit factor of a sector, in a quantifiable track able, way. this sparked some research to do. going back to lurk mode.

  • Ronebadger

    “The Masters” … I was at the practice round on Monday…very nice!

  • ridingwaves

    going to test that 2040 (204spy) one more time, my bet is support fails and heading to 2025

  • BKXtoZERO

    Great post Mole. Thanks! I was wondering about something like that for crude. There is a ticker for oil volatility in think or swim. I never made anything useful out of it. Nice VIX info. Let me know when TVIX goes to a gazillion 😉

  • mugabe

    when you go quiet, the market starts to move in your direction :)
    FWIW, the market tanking would probably hurt me quite badly in one of my accounts as configured at the moment, and not directly affect the other three at all, so I haven’t got loads of skin in this particular game.

  • mugabe

    no shortage of crude comments:)

  • ridingwaves

    you can now buy the push downs and scalp it, tide is changing

  • ZigZag

    np

  • Time Bandit

    GBP/JPY is doing its thing in Brilliant Fashion. How sweet it is. :)

    /QM hasn’t been too shabby either. As a rookie to the Futures Markets I’m finding that the biggest difference between Futures and the NYSE/FOREX stuff is the speed of how fast results can come. This takes a little getting used to and I’m already finding it difficult to manage trades in the same way that I back tested them on paper. The main reason is that on paper, it’s simply an excercise. But in a real trade it’s real money. :) So for my first /QM Trade this morning, I moved my stop in a little too close and got stopped for a +.83R Gain. If price goes lower from here (which it already has) and would not have hit the stop that should have been in place, it’s a mistake. If price goes up from here it’s still a mistake. If possible, I’ll try to find a MFE point in terms of R. In the mean time, my /ZL Short got stopped for a -.39 Loss. So I wound up with a Net Gain of +.44R on two Day Trades initiated this morning. BTW, I try to make my entries on Day Trades between 9:30 AM and12 PM. (I don’t know how Skynard had the stamina to make Day Trades around the clock.) :) My GBP/JPY Short is still open and is currently up +6R. My long XLB is down about -.6R and so far refuses to die.

    It looks like most of my Futures Trades will be mostly Day Trades so rather than post each trade as they come, I’ll probably put out a Friday Afternoon Recap somewhat similar to what Saltwater Dog has been doing.

    I’m pretty much done for the day although depending on prices, I might add/subtract some ERY, OIH, XLB at the COB.

  • ridingwaves

    Rod Carew was so steady while breaking out with multiple hit games…
    good trading TB

  • Edd

    Thanks for sharing your initial experiences TB. I have been and remain fearful of moving to futures since I do not trust myself. The ability to trade 24/5 while satisfying so many concerns associated with overnight issues, are offset by my own inability to leave the casino so to speak. I recently moved from 5 and 10 minute charts to the daily and while adjustments are harder than I thought, the quality of life has improved dramatically. I will be looking forward to your commentary as you implement this change

  • randomuser6789

    Regardless what volatility does, you can be guaranteed that 1/TVIX will go to a gazillion. That thing decays like crazy.

  • Mulv

    Mole – do you adjust your volatility measure (the Mole) for regular RV seasonality between night and day sessions? I tried doing this by bucketing bars according to my beliefs about the session players present (Asia, Europe, and USA) and looking back over multiple sessions, but never got a satisfying result.

  • Time Bandit

    Thanks RW.

    Well I’m 3 for 6 in Futures for the week so that has me batting 500. LOL But most importantly my net on these 6 Day Trades is +1.6 R :) I wont be making any more Futures Trades this week. I’m done for today and I’m going to try to leave Fridays alone.

    Holy Smoley on RLYP up over 50% so far today. I assume you have some of that. You’ve always done well with Biotech. Congrats to you too!

  • http://evilspeculator.com Sir Mole III

    Not sure what you’re asking me Mulv – I think the indicator is actually pretty clear in how it measures RI.

  • http://evilspeculator.com Sir Mole III

    Keep your position sizing TINY for the first year. You really need to develop a deep understanding of how those markets flow.

  • Ronebadger

    5 min chart – gotta blast below SPX 2040 for me to short some more.

  • ridingwaves

    2025 tomorrow and if we end red more on Monday…

  • Time Bandit

    Thanks Edd. I have the same fears that you do. This is why I try to only make entries between 9:30 AM and 12:00 PM on Futures. The rest is all trade management. If there is no proper entry to be had during these 2 1/2 Hours then I’ll pass until the next day. Back in my previous day trading days, I made shitloads of day trades like they were candy and ended up totally drained every day. Not only that but the more trades that I made the more chances I had of accomplishing a zero sum game. So certain changes had to be made like if I have 2 Losses, I’m done for the day. Also once I’ve been fed, I’ll walk away from the table because I learned the hard way that trying to be a pig is a loser as well.

    I certainly understand what you mean about the quality of life etc. You are the only one that knows what’s best for you. Most importantly what you realize and that “some” people can not understand is that there is not a one size fits all method of trading. There is trading a PLAN that has an edge that fits a traders personality. Or there is trading on gut and emotion which is almost guaranteed to become a loser. I’ve done both and you know as well as I do that the former is a hell of a lot better than the latter. :)

  • ridingwaves

    target is 25 and see if I can buy in later, will sell 1/2 at end of day regardless, blow off top time in bio, XBI and XLF followed the plan, more red coming

  • Mulv

    There seems to be regular cycle of RV as sessions transition. For example, RV for ES is miniscule from 6 pm (NY time) to 9 pm, it picks up somewhat after China opens, picks up more when London opens around 2:30, and then jumps when the US exchanges open or US economic numbers print. If you’re looking for a signal that vol is really changing, would you not want to filter for that regular variability? I think can be done using tick or volume bars rather than time, but I was wondering if you had thought of this in rolling your indicator.

  • Time Bandit

    Absolutely Mole. I’m only trading the Minimum of 1 Contract per Future Selection. I can dream about trading “CARS” someday but I have to be able to crawl before I can walk. :)

  • Time Bandit

    Beautiful RW. How sweet it is! :)

  • Kevin Mcdonald
  • almez

    I feel like this H&S pattern is a bear trap. Although the zero has been negative the entire day, the zero isn’t printing a divergence.

  • Edd

    Thanks Bobby. I have yet to master the ability to walk away from the screens during most days and let my trades “do” whatever they are going to do. I do not change them, but I still have not broken my years of habit of watching price action, tick by tick. I`m workin` on it! Trade access 24/5, the wife of over 40 years would kill me. My current trading plan has evolved over 5 years but is fundamentally the same plan I made back then. It is more me and my actions that needed the work. My plan is unique to my view, etc. It works best when I simply let it run robotically. Boredom is my tell to let me know I am following my rules, day in and day out, marking down my gains and losses, reviewing my performance and making sure my plan still performs and if not why not. I will follow you once again, but not till and unless I prove I have mastered my daily time frame systems personal performance demands. Until then I`m reading with rapt attention my friend!!

  • http://gerb-reloaded.blogspot.com/ Gold_Gerb

    28 red points?! It’s getting interesting now.

    if you made big deep coin over the past month. I assume your (long) trailing stops are kicking in.

    http://stockcharts.com/h-sc/ui?s=%24BPSPX&p=D&yr=0&mn=6&dy=0&id=p02855803153
    -GG

  • Time Bandit

    Hey Billabong,

    I think it was you who joked about Gartman calling for a Short in Corn on Monday. On Monday I bought Corn at 354. (I’ve been in and out twice since then 1 W and 1 L) but the main thing I want to point out is that the last print today was 361.50. That’s 7.5 Points and at a .25 Tick = to $12.50 that’s 30 Ticks x 12.50 = +$375 per Contract.

    Gartman does it again! LMAO Seriously though, I have a few memories of back when I owned a lot of Fannie Mae and like a lot of people who still look to others to say something good to help stay in a bad trade Gartman was saying Buy FNM with Both hands. He said things like undervalued, oversold all the way down to next to nothing. This was one of my biggest losses ever. It was still my fault for holding on to a loser like this but I guess some things have to be learned the hard way.

  • http://gerb-reloaded.blogspot.com/ Gold_Gerb
  • Time Bandit

    I don’t know who is worse. Gartman or Cramer. OMG!

  • http://evilspeculator.com Sir Mole III

    Well, I actually trade the full session and want that data. And if you curtail the session then you get gaps – not sure how that would be useful.

  • Mulv

    Thanks for the post and replies. Love this topic and will have a further think after re-reading your post tonight. If I come up with something, I will pass it along.

  • Kevin Mcdonald
  • Ronebadger

    NOW, we’re getting somewhere – VIX 60min

    http://stockcharts.com/public/1092905/chartbook/428507379;

  • mSquare

    Gartman MUCH worse.

    Cramer is surely off-the-top crazy but he is fun to listen to. Many times he even gives good / sane ideas such as someone starting out have index funds, stay away from ebenry, do not chase yield etc. Also buy and sell in increments or even the fact one should have a sell discipline.

    Lastly, some stock-specific calls when he is obviously has biases (like ones where CEOs appear often there) are good contra-indicators one can use and trade against his (typically bullish) suggestion to bank some coin!

  • Kevin Mcdonald

    and here comes the stick save to the closing?

  • Billabong

    He’s in the public realm and needs to be thoughtful when throwing out WAGs or talking his book …. eventually the Gartman (opposite) trade won’t work because all the loyal followers of Gartman will be BK.

  • Billabong

    Cramer is a great front runner for his “charitable trust”. One day the veneer come off his CT and he’ll be exposed for what he is…

  • Time Bandit

    I wonder if the new movie “Money Monster” starring George Clooney is loosely based on Cramer.

    https://www.youtube.com/watch?v=qr_nGAbFkmk

  • Billabong

    I wonder if anyone went short the banks today? Of the money center banks, C wins the award at -4%, GS, JPM, BAC, WFC roll in at -2.6 to -3.11%.

  • ridingwaves
  • Yoda

    Well, with OPEX next week, the next few days should be interesting to say the least.

  • newbfxtrader

    He was. Have you seen the Jon Stewart interview of him? It was years ago.

  • http://gerb-reloaded.blogspot.com/ Gold_Gerb

    Keep an eye on gold.
    always volatile, but may be breaking downtrend of highs.

    http://stockcharts.com/h-sc/ui?s=GLD&p=D&yr=0&mn=3&dy=0&id=p29918880124

    EDIT: TLT also perking up, somebody is making a move to safety.
    -GG

  • ridingwaves

    sold 1/2 at 25, ts at 24..

  • almez

    The small zero uptick at the end is promising for bulls. The zero opened extremely negative and came back into positive territory even though price action was down. I’m positioned long

  • Billabong

    GC needs a solid break above resistance at 1250 … I was looking for a buy signal today, no joy.

  • http://gerb-reloaded.blogspot.com/ Gold_Gerb

    Rules are rules.
    without them you eventually end up lost.

  • Billabong

    Yes … It’s really funny (2007/8). There’s another JS piece on Cramer, accusing him of misrepresentation and JS does a snide apology (also funny).

  • Billabong

    And some times the turtle wins the race…

  • BKXtoZERO

    BKX…… to zero ;-0

  • http://gerb-reloaded.blogspot.com/ Gold_Gerb

    VIX fans,
    RSI close above 50. let’s see if tomorrow follows-thru.

    http://stockcharts.com/h-sc/ui?s=%24VIX&p=D&yr=1&mn=2&dy=0&id=p08570653919
    -GG

    old chart.

  • BKXtoZERO

    I see a lot of “1s” going by on Think or Swim level 2 quotes, now I will wonder if one was yours 😉

  • BKXtoZERO

    Looking pretty spiffy today….

  • newbfxtrader

    Gold? Looks like a good short. Buy levels are a 100$+ below…

  • newbfxtrader

    Yeah. Thats what I use too. Keep stops wide so I can keep positions open for weeks.

  • http://evilspeculator.com Sir Mole III

    That was a good Mole signal, well done.

  • Yoda

    Much depends on what King $ does in the next few days.
    On the weekly chart we are at support of a range, and a bounce back up is a possibility. However, for the longer term, I do not find the monthly chart particularly bullish (as in double top formation or failed retest of the high).

  • Yoda

    Peter Brandt has however a different view on the L-T direction of the $

    Anyway, don’t get married to a trade and be ready to reverse position if it goes against you.

  • mugabe

    looks more bullish than bearish to me

  • http://gerb-reloaded.blogspot.com/ Gold_Gerb
  • http://evilspeculator.com Sir Mole III