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Possible Shutdown, Yellen And Volatility

Summary An update on the current volatility landscape. Possible backwardation scenarios. A look at how previous events have effected UVXY. There has been talk, from both sides of a government shutdown. This article will look back on the recent shutdown and how that effected volatility. For the basis of discussion, we will use the ProShares Ultra VIX Short-Term Futures ETF (NYSEARCA: UVXY ). We will also examine the recent Federal Reserve commentary and how that could also affect December volatility. Previous Shutdown The last time the U.S. government shutdown was on October 1, 2013. In the history of the U.S. there have been several funding gaps and government shutdowns due to issues from abortion, the budget deficit, health care, and general political showmanship. In the weeks leading up to the last shutdown the front month VIX futures contract traded between $14-$15 (it currently trades around $18), roughly speaking. It climbed and peaked at a closing price of $19.40 on October 8, 2013. In the weeks following the resolution front month futures quickly settled back to the $14-$15 area. See below for a charts on how UVXY reacted during the 2013 shutdown: (click to enlarge) Current Situation One important fact to note is that 2016 is an election year. 2013 was the year after an election year. Bold and risky political decisions are usually made when the repercussions have more distant consequences. I believe the current situation is nothing more than the political showmanship and bickering that we have seen over the past decade. In the end there will probably be a last minute deal that doesn’t solve any of the real problems and kicks the can down the road for someone else to take care of. The Federal Reserve Janet Yellen has single-handedly been volatility’s best friend the last several years, with one exception. That exception was the August meeting where markets were expecting a signal on rate increases and nothing happened. Why would Janet do this? She knew that’s what the market wanted and has followed their demands for so long that it should have been a no-brainer (satire). This spooked the markets and caused a major spike in volatility which hadn’t previously been seen since 2011. At the September meeting nothing happened again and there was another small increase in volatility. Markets were spooked because they now view the Federal Reserve rate increases as a predictor for the strength of the economy. If the economy was healthy and inflation was expanding at a more robust pace, rates would already have been raised. However, time after time global economic weakness and slack in the labor market continue to be cited as cause for concern. See below for the UVXY reaction during those events: Conclusion We once again approach a potential, but unlikely, government shutdown at the end of next week. After that Yellen is back up to deliver the final bit of big news before Christmas. Will Yellen be naughty or nice to the markets? I am focused on a 0.25% increase in rates and Yellen’s comments on the overall economy. Markets will be focused on comments relating to the pace of future increases. If you are a regular reader, we discussed an increase in volatility throughout the second half of 2015 and into 2016. We certainly have seen that uptick and I continue to expect increased volatility levels due to the level of uncertainty in the markets. There are currently many unanswered questions about the economy and what I view as the new normal of slow growth. Job growth continues on its positive track and has been the bright spot in the overall economy. I am working on a very interesting piece that focuses on the psychology behind volatility and how irrational moves by others can make rational gains for your investment account by using volatility ETFs such as UVXY. For more information about UVXY, I recommend viewing this article that gives a beginners guide to the unleveraged version of UVXY, which is the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ). We have two more weeks until school is out for break and I look forward to relaxing with family. I hope you have the opportunity to as well and wish your family a very happy and prosperous holiday season and new year. My current advice is to stay patient and up to date with current events. Keep a keen eye on U.S. economic indicators heading into 2016. It wouldn’t take much to move this economy into negative territory which creates perfect opportunities for exaggerated irrational behavior. It is a risky time to be involved with both inverse and long volatility products such as UVXY. I would remain on the sidelines and wait for a clearer opportunity of shorting volatility to present itself (for more information on my theory of only shorting volatility and when to do it, view this article ). If backwardation levels rise over 5%, then I will begin to pay attention to what is happening. Ultimately in this environment I would expect a maximum backwardation event of around 20% (excluding a war). Let August be your guide as to how quickly this market will hit the panic button. For now just sit back, relax, and don’t do anything greedy until the right opportunity presents itself. As always, thank you so much for reading and we will speak again soon.

5 Lessons Learned From VIX ETFs

The CBOE VIX Volatility Index is an interesting animal that has grown to become one of the most heavily watched indicators of fear and greed in the market. There are currently 20 dedicated exchange-traded funds and exchange-traded notes that attempt to track this index with varying degrees of success. By their nature, VIX funds are a non-correlated index that is essentially a way to measure when the stock market starts to get shaky. The CBOE VIX Volatility Index is an interesting animal that has grown to become one of the most heavily watched indicators of fear and greed in the market. This index functions by measuring near-term volatility expectations from options activity on the S&P 500 Index. It’s calculated on an intra-day basis, so investors are able to watch as implied volatility expands or contracts in real time. The CBOE has a nice primer on how this is accomplished that you can read here . As many ETF investors know, you can’t invest directly in an index. So the forward-thinking asset managers at Barclays, ProShares, and VelocityShares set out to create several products to help you invest in the movement of the VIX Index. According to data from ETF.com, there are currently 20 dedicated exchange-traded funds and exchange-traded notes that attempt to track this index with varying degrees of success. The two largest funds in this space are the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ) and VelocityShares Daily Inverse VIX Short Term ETN (NASDAQ: XIV ). Both of these funds currently have over $1 billion in assets under management. VXX is a bet on the expansion of volatility, which typically comes during a correction or choppy stock market action. Conversely, XIV is an inverse play that rises when volatility contracts. This fund is intended to move higher as stocks move higher and greed takes a more prominent position in investor sentiment. There are also many other flavors of VIX funds that offer varying degrees of unique tracking and index construction methodology. Nevertheless, XIV and VXX work well as benchmarks to understand this unconventional asset class. I have been watching and even invested small amounts in these funds for my personal accounts at one point or another and these are the lessons I have learned from the experience. They aren’t for the faint of heart. By their nature, VIX funds are a non-correlated index that is essentially a way to measure when the stock market starts to get shaky. It’s difficult to use these as a forecasting tool and they are often susceptible to VERY fast swings in price . They should truly only be used by disciplined traders, investment professionals, or those who understand their unconventional nature. In my opinion, they should only be held for very short periods of time with a tight stop loss to guard against significant downside risk. They don’t track all that well. These VIX funds work by tracking futures contracts similar to a commodity fund like oil or natural gas. That in itself causes problems in accurate price movement over long periods of time as complicated forces like contract rolls, contango, and expenses work against these products. The chart below depicts an overlay of the actual CBOE VIX Volatility Index and VXX. The movements are certainly correlated to a degree, but you can see how over time the price of the exchange-traded product continues to decay versus the spot price of the index. They aren’t cheap. The listed annual expense ratio of VXX is 0.89% and XIV is 1.35%. It should be expected that a fund investing in futures contracts will naturally generate higher expenses because of the complicated nature of the process. Nevertheless, it’s important to understand that these funds are going to eat into your pocketbook as well. Some come with tax headaches. Most of the investable VIX funds are structured as exchange-traded notes, which do not experience adverse tax consequences. However, if the fund is structured as an exchange-traded fund, it may be susceptible to tax consequences in the form of a K-1 that must be accounted for as well. The K-1 is generated because you are participating as a shareholder in a partnership rather than a trust. It goes without saying that you carefully read the prospectus before investing in any of these funds. They are entertaining to watch. Regardless of whether you use these vehicles, they can be entertaining to watch and also offer some insight into the market’s fickle machinations. VIX ETNs allow individual investors the ability to monitor in real time the current sentiment towards stocks and may provide a piece of the puzzle for short-term traders. They also offer a technical dynamic that may be useful for investors who are fans of relative strength or other momentum indicators. Sharp inflection points in the VIX may point towards a turning point in the market that precedes a big move (up or down). The bottom line is that these products are primarily geared for advanced users with a high tolerance for risk and sophisticated knowledge of the markets. Those that choose to dabble in these funds should only do so with a well-defined risk management plan that protects your capital in the event of a reversal.

IMF Green Signal Put Yuan ETFs In Focus

The Chinese economy is telling us two different stories at a time. While on one hand, the economy is persistently delivering offhand economic numbers, and even raised hard landing fears at some point of time, on the other, its currency – yuan – received a privileged reserve status from the International Monetary Fund (IMF) recently. Notably, the inclusion of the yuan in the IMF’s reserve currency list gives the economy a cream-of-the-crop class, as this emerging currency will now sit beside the developed currencies like the U.S. dollar, pound, euro and yen. Also, the IMF nod indicates economic stability in China. The IMF’s executive board, which represents the fund’s 188 member nations, recently settled on the fact that the yuan now enjoys a “freely usable” status. The move marked the first change in the SDR’s currency portfolio since 1999, per Bloomberg . Not only this, China’s currency will have a weight of 10.92%, higher than that of the yen (8.33%) and the pound (8.09%), but lower than the euro (37.4%) and the U.S. dollar (41.9%) weight. The move will take effect in October 2016. Why the Move? Though several theories are doing rounds right now, both positive and negative, the IMF viewed it as the consequence of reformative measures presently being undertaken in China. However, one school of analysts addressed the decision as “political,” and is not counting on the easy accessibility of the currency, because the yuan cannot be transferred into other currencies without restrictions. The believer of this school also indicated that the IMF head “realized how bad things are in China, so what she (Christine Lagarde) decided to do was to throw China a lifeline.” This way, the IMF boss can press the Chinese government to launch a total convertibility for its currency. Notably, the Chinese economy is on its way to deliver a 25-year low expansion this year. Despite the roll-out of a flurry of measures, the economy has showed no signs of a steady recovery, and the financial markets remained highly volatile due to extreme risk-taking. Investors should also note that movements in the yuan market have been rampant this year. In August, China’s central bank devalued the currency by 2%, following which yuan posted the largest single-day decline since the historical devaluation in 1994, after the country arranged its official and market rates in a line. Notably, the Chinese authorities follow a trading band around the official reference rate it sets each day for the value of the yuan against the dollar. The Chinese government announced in August that the renminbi’s central parity rate would follow the previous day’s closing spot rates more closely going forward. This indicates China’s intent to make its currency more market-driven. As a result, a section of analysts believe that the actual motive behind this currency move was to prepare the yuan as a reserve currency. Most importantly, the Chinese central bank assured the market that it would promptly intervene in the currency market if depreciation crosses the 3% mark. Busy Trading in Yuan The yuan became the fifth-most active currency for global payments by value in October, with a market share of 1.92%, per the global transaction services organization SWIFT . Not only this, the Chinese currency beat the Hong Kong dollar and the U.S. dollar for payments between Japan and China/Hong Kong in October. Standard Chartered and AXA Insurance estimate that the IMF’s green signal will offer the yuan a minimum of $1 trillion of movement. Needless to say, this historic move makes it important to look at the Chinese yuan ETFs. WisdomTree Chinese Yuan ETF (NYSEARCA: CYB ) The most popular Chinese yuan fund is CYB from WisdomTree. The product invests in short-term, investment-grade instruments in order to be reflective of both money market rates in China available to foreign investors and changes in the value of the yuan against the dollar. The product charges investors 45 basis points a year, but sees decent average volumes of 50,000 shares a day on AUM of over $64.4 million. The fund currently has a Zacks ETF Rank #3 (Hold) with a Low risk outlook. It is down over 1.2% so far this year (as of December 1, 2015). Market Vectors Chinese Renminbi/USD ETN (NYSEARCA: CNY ) For investors seeking an ETN way to target the Chinese currency, CNY is the right option. This product tracks the S&P Chinese Renminbi Total Return Index, which looks to track the performance of the Chinese currency against the U.S. dollar, by rolling three-month non-deliverable currency forward contracts. The fee is a bit higher at 55 basis points a year, while volume comes in below 5,000 shares a day, suggesting a wide bid-ask spread and ever-increasing total costs. The product is down 0.6% so far this year. The ETN currently has a Zacks ETF Rank #3. CurrencyShares Chinese Renminbi Trust ETF (NYSEARCA: FXCH ) This product looks to track the price of the Chinese renminbi net of Trust expenses. The product has amassed about $7.7 million in assets, while it sees weak volumes of around 1,000 shares a day, suggesting a wide bid-ask spread. On the positive side, the ETF has the lowest expense ratio at just 40 basis points a year in the Chinese currency ETF space. The fund has lost 2.7% this year and carries a Zacks ETF Rank #3. Original Post