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State Of Volatility
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State Of Volatility

by The MoleNovember 8, 2017

Market volatility in all shape and form has over the years turned into a personal passion and lies now at the heart of my current system development efforts. There are several reasons for this, the first most likely being one you probably have heard about before, which is that volatility appears to be a lot easier to predict than market direction. Your mileage of course, as with all things in life, may vary considerably plus as you slowly embark on peeling this onion you’ll discover there are many layers hiding below the surface.

The second reason why I have increasingly shifted toward trading volatility is lesser known but it’s actually the most important one: it is truly mean reverting in contrast to practically every price series which all in essence follow a random walk. And I’m not just making wild claims here – I have actually proven for this to be the case.

ADF Test

You can do this as well by simply (yes, I’m being a bit cynical here) running the VIX through an Augmented Dickey Fuller test to check for stationarity (fancy word for ‘is it mean reverting’?). Which is exactly what I did – and more:

p-value = 0.0321613338723 The series VIX is likely stationary.
p-value = 0.103166277707 The series VXV is likely non-stationary.
p-value = 5.73166440286e-06 The series VIX/VXV is likely stationary.
p-value = 5.73166440286e-06 The series VIX/VXV is likely stationary.

In general, a p-value of less than 5% means you can reject the null hypothesis that there is a unit root. SAY WHAT?? Yeah, that’s exactly how I felt when I first read this back when, so I went digging for an explanation that non-pocket-protector-wearing-mortals like us could understand. Fortunately I came across lovely Mr. Nystrom who’s not just a bonafide math-genius but also knows how to explain complex math related topics but also wears silly hats:

Okay, that was different but we get it. The null hypothesis assumes the ‘boring’ assumption that this series is like all the others, i.e. non-mean-reverting. So how about the root thingy? If you look up ‘unit root test‘ in the Wiki you’ll find this right at the top:

In statistics, a unit root test tests whether a time series variable is non-stationary and possesses a unit root. The null hypothesis is generally defined as the presence of a unit root and the alternative hypothesis is either stationarity, trend stationarity or explosive root depending on the test used.

Ahaaa! Now we’re getting somewhere. So that p-value basically gives us the odds that there is a unit root, meaning that it is non-stationary. And 5% is our standard threshold, which the VIX seems to be satisfying. Which percentage you choose for the ADF and other statistical tests is always data dependent and there is not right or wrong. You as the human being have to consider the implications of being wrong, meaning how probability of being wrong you are willing to accept. For the ADF a 5% threshold is commonly accepted.

2017-11-08_VIX_VXV_stats

Interestingly the VIX on its own is considered stationary per the ADF, but the VXV is not. More importantly however the VIX/VXV ratio, which I use a lot, is considered stationary. Here I’m plotting the past decade of the ratio and although this is very subjective I think it’s fair to say that it is mean reverting.

Cointegration Test

But why use those two as a ratio? Are they actually moving in relative tandem with each other? Well, there’s another statistical test called the Cointegration Test. In order to run it you need two price series of the same interval (i.e. weekly, daily, hourly, etc.) which it will test for the probability of cointegration. This is what it’s spitting out:

t-statistic: -10.0428682
p-value: 1.93501804248e-16
Critical Value 1%: -3.43305394343
Critical Value 5%: -2.86273457071
Critical Value 10%: -2.56740591915

Don’t worry about the t-statistic, what’re once again focusing on is the p-value which has a negative exponent of 16 and that means the value is tiny. In other words, yessirree, those two are cointegrating for sure.

Covariance And Correlation

Not to throw too much at you today but you probably also want to test for covariance and correlation. The latter is conveniently scaled between -1 and +1 depending on whether there is positive or negative correlation, and is dimensionless. The covariance however, ranges from zero, in the case of two independent variables, to Var(X), in the case where the two sets of data are equal.

Covariance of VIX and VXV: 83.1724666524
Correlation of VIX and VXV: 0.980667242113

Correlation usually is more intuitive to most people and I think a value of 0.98 is pretty damn correlated.

2017-11-08_VIX_VXV_scatter

The scatter plot makes it pretty clear although we’re also seeing a tad of heteroskedasticity at work. Hey, no reason to be insulting!! Okay, I’ll explain that one another day.

Back To The Basics

Now that we actually know what the heck we’re talking about and can back it up with proof let’s actually look at some recent IV charts:

2017-11-08_VIX_VXV

So here we’ve got the VIX on top and the VIX:VXV ratio below as candles – the first is the ratio and the second the spread between the two on a percentage basis. I know – FANCY!!

But what does it tell us? For one the ratio seems to be plotting a pretty solid support zone which we recently touched and now seem to be bouncing from. Which probably means we’ll be seeing an increase in volatility in the coming weeks and months. Most likely after the Santa Rally in January though.

But it’s just getting interesting. Please step into my lair:

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Campaign Updates

2017-11-08_copper_stop_out

Dr. Copper not surprisingly found its maker overnight. Commodities are clearly being affected by a strengthening Dollar and for now we’ll have to be careful when picking long candidates in this sector.

2017-11-08_ZN_update

10-year bonds have however happily continued higher and our current trail remains intact until we hit 2R in MFE or a new spike low is in place.

2017-11-08_crude_exit

Last but not least crude which has also ended but not before leaving us with another juicy 4R in profits. That was our 2nd crude campaign in the past 2 weeks and both turned out exceptionally profitable. Wish it was always that easy!


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

    It’s pure genius that you have a statistical model to analyze a statistical model, the VIX. The trouble I have is you can’t trade the VIX, it’s a byproduct of the SPX. The /VX is an entirely different monster. Has different characteristics than the VIX and certainly a VIX:VXN highfalutin ratio. Does it actually translate to the VX or does it get subjective at that point? ie, Monday VIX gapped up and VX was down all day.

  • Mark Shinnick

    Way good on that vol study Mole !!!

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

    I look at it as really more the “buy” product of futures premiums induced by a manic environment – out of relative proportion to the spx.

  • ridingwaves

    S out AVXL
    1/2R L BOIL

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

    might be a good play at double bottom area…..Important juncture for bio indexes here

  • Mark Shinnick

    Ok, will trak it down.

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

    Ouch! My toad brain hurts. I’ll have to re-read this wealth of info after hours.

  • HD

    ha, Some will “buy” that. I’m still pretty new to VX and even accepting of the VIX as useful. Most people think it measure complacency or fear. It’s just math. So Mole doing math on the math has value to the VIX. I’m not sure how it translates to trading volatility though. Hence the question. Is the VX worth it’s own study? It has some very nice characteristics, repeatable characteristics. Still haven’t found patterns but 2 things you can look at:
    1) the contract roll and price action in days immediately after.
    2) everytime there is a 9% spike in VX and the price action in hours immediately after. JMHO

  • Darrell Osgood

    So VIX and VXV look and act differently, like apples and oranges, but cointegration says that you can turn this orange into an apple (or maybe turn them both into a delicious hybrid). The t-statistic tells us how much we need to manipulate the orange before it becomes an apple. All in all, doing the math is not hard. It is knowing which math to do that is the hard part.
    But how do you trade volatility? I hear that VIX related ETFs are poor approximations of the real thing (like dating Cinderella’s ugly step-sister).

  • Brishort

    Excellent venturing into new territory Mole. Great work and even greater condensed but clear explanation. Many analysts in the bulge bracket firms could only dream of being able to come up with what you did and posted for all to see. Great work and congratulations again.

  • ridingwaves

    the 8/14/17 SNAP block buyer is holding strong, oversold now…

  • robert sullivan

    VIX seems to be more Mode Reverting than Mean Reverting. It spends very little time at the high extremes yet those extremes pull the mean up pretty high.

  • Mark Shinnick

    Well, going to your point, for me the practical vehicles are the 2x / 3x, where the emotional component is the rubber actually meeting the road.

  • HD

    same issue, The VIX gapped up 6% Monday, UVXY lost 1%.

  • Mark Shinnick

    Ok, all handled in that lens by tracking uvxy price itself while under notice of the vix. The thing is, there is no way in the first place one should ever be taking a position in anticipation; one must trak the trading price animal until he actually credibly reverses.

  • HD

    hmmm, most are selling volatility. Let’s see what the boss says.

  • ridingwaves

    pushing bio indexes around here on light volume..

  • Mark Shinnick

    From a game theory POV, I’m supposing avxl just needs to test that zone a bit. Is this a little baby in bath water sort of thing?

  • HD

    I looked at the week before OPEX last month and VIX did the same thing on Monday. For all we know the bastrdos are just pricing options for next week.

  • Mark Shinnick

    A word true to the nature of life.

  • kim

    bitcoin fork was cancelled and it’s going north like crazy… it’s amazing to watch no sell orders, just buy….

  • ridingwaves

    a month ago 4200….amazing

  • kim
  • ridingwaves

    CL still powering thru

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

    Ooooo,
    pretty colors [Live Feed]

    http://bitcointicker.co/

  • Yoda

    Sometimes a poor retail trader has to content himself with the ugly step sister, especially if she can also suck a mean dik.
    😉

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

    saudi princes hiding their riyal stash.

  • Mark Shinnick

    Meanwhile, Chinese with the cheapest electricity are churning these things out and then releasing them. One might say its a fantastic Communist conspiracy upon the rest of the world.

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

    That’s right, damm cities there like Beijing are miserable.

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

    Yeah…and nobody seems to care the Chinese have annexed Hawaii within their official govt maps.

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

    ….Obama and his lines. However…No mere coincidence about this!

  • StockTalker

    Don’t look now

  • ridingwaves

    getting close to that fan line

  • kim

    why not, i put some small short :)

  • Yoda

    19th century stuff

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

    it’s just a line, ad-hoc I might add.
    double check my work.
    could be a grind next few days, might pierce.
    😉

  • StockTalker

    lol, good job

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

    sure. but they have mouths to feed.

    https://tallbloke.files.wordpress.com/2013/01/coal-fired-plants-map-001.png

    here is a shocking graphic.

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

    “One plaintiff was tied up, gagged and shocked with a cattle prod in her groin before Rubin allegedly raped her”
    Evil Soros taught him well… sarc/

  • Mark Shinnick

    Oh mann…its a pure emotional market, ok….but its so corrupt.

  • Yoda

    Yuk!

  • kim

    day will come when we will see hodlers crying :)

  • http://evilspeculator.com Sir Mole III

    It’s old territory for me but thanks! 😉

  • http://evilspeculator.com Sir Mole III

    Actually I’m trading several pertinent ETFs rather successfully. But fine – keep saying that, all the same to me 😉

  • http://evilspeculator.com Sir Mole III

    The reason for that is because the VX futures are in contango. You don’t want to hold long for more than a few hours and the same applies to pertinent ETFs/ETNs.

  • http://evilspeculator.com Sir Mole III

    Good explanation.

  • HD

    ok I’m lost- keep saying what?

  • Julie

    TAL Lower high and lower low . I be short !
    JULIE

  • http://evilspeculator.com Sir Mole III

    That the VIX or other pertinent IV measures are more or less useless. Unless I misunderstood your POV. You seem pretty passionate about it.

  • Julie

    Forgot small short probe retained INTC. Stop 46.84
    JULIE

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

    the hourly RSI was (or came close to 50) but no joy.

    http://stockcharts.com/public/1006933/chartbook/497133638

  • Julie

    Hi GG Daily 5 ema 46.29 and the low today so far 46.28 Would like to see a bust down thru
    JULIE

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

    the fast STO 14 is ready to reverse higher.

    QQQ’s are too strong.

  • Julie

    GG The Williams % is a good indicator. INTC 60 min and lower time frames a possible bearish rounded top and I mentioned yesterday of a possible small ascending triangle forming. The triangle may be out the door
    JULIE

  • HD

    Just my eyes I guess, The question or example was Monday VIX gapped up and VX and the etf’s were down.

    Wasn’t trying to trigger you. Is group think the only thing you’re after?

  • Julie

    GG INTC breaks down thru it’s daily 5 ema …. Next stop support at approx. the Ichi Cloud conversion line approx. 45.36 matching a support. Then down to gap approx. 43 matching the daily 21 ema and the Ichi Cloud baseline. Watching closely GG
    JULIE

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

    critical point in time.
    If the MACD histogram doesn’t cross below zero, watch out!

  • Julie

    GG MACD (3,9,16) is excellent too Can also use PPO
    JULIE

  • Julie

    GG INTC Weekly and monthly charts. Weekly overbought Red horizontal line a resistance @ 47 Monthly chart overbought. We also discussed the parabolic rise on the daily chart Shown Weekly and Monthly charts https://uploads.disquscdn.com/images/4790fa70d04e9c8e004adc0b6e0db09f32b3445a70c338895666bf10834fce5e.jpg https://uploads.disquscdn.com/images/56c73e85f1c91a6baa64cbd9ecf454c599f658a5f6a44691fd3f53399de9e635.jpg JULIE

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

    they all look good. the hourly remains.

  • Julie

    USO I showed this chart yesterday….. I would be careful long oil now JULIE https://uploads.disquscdn.com/images/99fb445c285194ca3a7dfb67b197f52408446f6ad69507b3c73d7d868dcef041.jpg

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

    GG I like your usage of exp mov ave envelopes
    JULIE

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

    cool.
    Shhh (ancient Chinese secret)

    if you get the MA’s right, the bottoms will tell you where the tops are.

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

    almost as bad as wave counting. {snort}
    they should be used sparingly. IMHO.

    EDIT: don’t get me wrong, I like the time element built in.

    its –
    “The price is unlikely to respect the exact price of a Fibonacci Arc level.”
    https://www.binaryoptions.net/how-to-use-fibonacci-arcs/

  • Julie

    TAL Breaks down thru it’s daily 5 ema matching the lower cloud boundary will add to short. RSI below 50
    JULIE https://uploads.disquscdn.com/images/67a12088e3918acd725eefa6c8347f26d5abcca95dc352102eea1f125e0700b1.jpg

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

    humble question,
    isn’t it risky to ADD just an hour before closing?
    why not add in the AM on confirmation??..

  • Julie

    Very true statement GG. Holding over the weekend too
    JULIE

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

    Lets see, half hour to close.

    anything on the rest of this week’s radar?…..Claims
    https://finviz.com/calendar.ashx

    High Yield is quite soggy, but it has yet to turn the ole S&P. what gives?
    http://stockcharts.com/h-sc/ui?s=HYG&p=D&yr=0&mn=9&dy=0&id=p39365545672

    Perhaps a spike open to 2609, and then a FreeFall?, one could wish.

  • Mulv

    HYG getting late day pummelling

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

    ah yes, the credit market whisperer from yesterday.
    do tell us more.
    :-)

  • Mulv

    mommy…

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

    is that a noose?

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

    no, a horse bridle.

    EDIT: should it be? don’t do it man! it’s not worth it.

  • Mulv

    now i see it!

    idiosyncratic risk and dispersion in credit have picked way up recently. it usually takes something to wake PMs from their carry slumber. so far this move seems like complacent positioning getting squeezed out of credit more than fundamental re-pricing. forward outlook for supply is supportive for credit over the intermediate term. fundamentals suck, but the party probably doesn’t truly end until we achieve exit velocity with higher rates.

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

    I believe you. I’m going to need some of the rats to translate.

  • Mark Shinnick

    A world gone mad.

  • Mulv

    a few names and situations start blowing up (TEVA and QCOM, most recently in investment grade). investors realize that there actually might be some risk in the market. they sell to reduce overweights and dealers start pushing the market down to clear inventory. not unlike when vol pops off an “unsustainable” low.

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

    I’ve been seeing that relatively speaking with Losers of the Day.
    (overweights and dealers dumping losers)

  • Mark Shinnick

    Yes, a lot of equity bears just got positioned; it would be a great place to gap big against them.

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

    High Yield,
    you might want to pay attention.
    Yes. I am a very, Very patient Gerbil.

    https://uploads.disquscdn.com/images/cbc107533fa325cd61dcb3d073a08af1dcf94d67d3d676d914500355a0d7deea.png

  • Edgy

    P-value? Mean reverting? That reminds me of a saying I heard in one of the three statistics classes I have taken:
    “There are lies. There are damned lies. And then there are statistics.”
    But then there’s my own quote:
    “Numbers are MUCH more fun when you put dollar signs in front of them.”

  • http://evilspeculator.com Sir Mole III

    Wow you’re pulling out early but you definitely deserve it. Enjoy!!

  • http://evilspeculator.com Sir Mole III

    Who’s triggered? Interesting perspective… Just because you are unable to see an edge doesn’t mean others cannot. Not a big deal and I’m happily trading IV instead of arguing about it.

  • HD

    Dude, I am trading IV too and want to see an edge. I posted my idea of the IV crush in RT to the minute last week! That’s why I did a study today and contributed to your blog on the subject. I have no idea why you thought I was arguing about it? I simply stated, at times, the VIX acts different than any actual product related to trading the VIX. No worries.

  • Yoda

    Have a good rest Gerb

  • HD

    HD • 2 days ago C=A 2576, HAGWE