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Summary August 25 — a special day. On Seeking Alpha I urged being long SVXY and CBOE first publicly exposed its 9-day time horizon Volatility Index, accompanying the 30-day index. Market-makers and prop traders use VIX-based securities in their hedging. The longer the time to expiration of the contracts involved, the larger the uncertainty, the higher the cost. CBOE insiders had watched VXST, the new index, behavior privately for months before its release. Its shorter time horizon can advantage arbitrages and reduce capital haircuts. It’s embrace by other investment professionals and by the public was anticipated, but not certain. It turned out to have a dramatic effect on the established, longer-time index. On October 8th trading will begin in options on the VXST, further elaborating the shorter-term VIX-index securities inter-relationships web. Then we will have better expectations information. Meanwhile, tail wagging the dog? The CBOE has had since August 25 to see how options on the VXST should behave. No doubt they are conducting internal training sessions to encourage rational member trading activities. I have to believe they also learned from market reactions since August 25. Figure 1 shows how hedger expectations for the longer-term VIX index changed at that point. Figure 1 (used with permission) The VIX index is, excuse the expression, volatile. The forecast ranges for the index in Figure 1 are derived in the same way as our market-maker forecast reports on stocks and ETFs. The only difference is that the hedging in index derivatives is done in markets not easily accessible by individual investors, at a scale not inviting to personal portfolios. It should be evident that prior to late August this year the 30-day volatility index had a fairly reliable bottom around 12, with upper expectations reaching into the area of 20. Oscillations in that range provided upside excursions of as much as 75% (20-12) / 12 and might occur in a week or two. Playing that game adroitly (flawlessly) for a year or two could earn a comfortable retirement for generations of the family. But since August 25, there’s a new sheriff in Dodge. Whether he has brought more or less law to town is not yet evident. Madam CBOE’s establishment appears to have taken on a new vibrancy in the company of VXST. What it has meant for the ProShares Short VIX Short-Term Futures ETF (NYSEARCA: SVXY ) is alluded to in Figure 2. Figure 2 (click to enlarge) My guess is that there’ll be lots of moderately-restrained fun and adventure in town until the court comes to session, starting on October 8th. Then we’ll see what his honor Mr. Market has to say in judgment. Conclusion Stay tuned for intra-day thrills and spills while those with short-time horizons have their fun, adventures, greed and fear. Meanwhile, those with longer visions (out to the next calendar quarter at least) think there’s already lots more upside than downside among portfolio investment candidates. Check out yesterday’s market profile in Figure 3. Figure 3 (provided with permission) Pictured here are over 2500 stocks and ETFs’ price range forecast balances between upside and downside prospects. Normally the distribution would be centered around a Range Index of 40 instead of 21 (40% of the range to the downside, 60% up) with no or few screaming bargains on the left. Market outlook implication: fear has taken over, but may be fatiguing for lack of downside opportunity. If so, SVXY could again be attractive – but we’ll wait for October to decide. Share this article with a colleague Scalper1 News
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