VIX and Viagra

Mean Reversion
It's the theory that interest rates, security prices, or various economic indicators will, over time, return to their long-term averages after a significant short-term move.. In simplest terms, it defines the pull that returns things to where they usually reside. An analogy might be that of a young virile man who passes a young beautiful woman on the street. His head turns, his pulse quickens, his heart rate soars, his thoughts race. After a while these reactions dissipate and his levels revert to the mean, normal heart rate etc....until the next time he passes another beautiful woman. A chart of these changes might look something like this. Major Spikeage!

  

And if we fast forward 50 years or so when the same man passes a young beauty, his head will still turn, though he may not even remember why. His heart rate may quicken a bit but not nearly as much, and a chart of these changes will most likely jump much less and revert to the mean much sooner than it had years before. A chart of this might look like this. A small speed bump.

Physically, he it seems like he has pretty much reverted to the mean on a permanent basis......But, just when all hope is lost, God created Viagra! And happy days were here again.......
Which brings us to the VIX. On the chart below which encompasses VIX(Green bars) & SPY (White bars) weekly prices from 2003 - present, I have separated the dates by a "Blue" vertical bar in 2007. This bar represents the elderly fella during the pre viagra era and the post viagra era  There is a line at the 20 level on VIX, which usually separates periods of lower & higher volatility. Excursions above & below the line are highlighted in rectangles pre 2007 and Elipses Post 2007.The red dots on top of VIX show periods where the VIX has risen for 4 consecutive weeks. There are Bollinger Bands are  fixed at 2 sigma.
Finally in the lower segment of the chart there is a histogram which depicts the VIX's relationship to its 10 day simple moving average. The VIX and 10 day SMA is borrowed from an old friend from the Amex floor, Adam Warner who formerly wrote The Daily Option Report and now resides at Schaeffers Investment research. The concept is that when the VIX reaches 20% above its 10 day MA it is stretched and at some point will be pulled back to more normal levels, sort of like the eventual ending of a round of passion.

So lets make some observations. First, in the period from 2003-2007, excrusions in VIX from under 20 to over that level fizzled out pretty quickly. We see VIX topping out at between 21 & 24 on 6 different occasions. Instances of VIX increases for 4 consecutive weeks occured in only 3 clusters for a total of 7 weeks in those 4 years. The average VIX move from trough to peak was only 8.11. VIX rally to over 20% above its 10 day SMA occured only 6 times, never 2 weeks in a row, very uneventful. Certainly those holding premium rolled over and went to sleep very unsatisfied.
And then came the Viagra Era for the VIX. Since 2007 we have only 9 instances, but all of these were instances worthy of a Meg Ryan cameo. 1 instance of just below 30, 4 instances peaked in the 30's, 2 in the 40's and big one at 89.53 and the current trade at 21.87 as of Fridays close.There were 11 instances of 5 consecutive rising weeks and 4 of the 8 previous times that price bested the 10 day MA by over 20% were clusters of at least 3 weeks. The average increase from trough to peak was 22.67 approximately 2.8 times the rises from the pre viagra era. Fireworks on all occasions! Clearly there was a major change in the virility of the VIX. Not only reaching peaks previously unheard of but in staying power too.
So now here we are, VIX has risen from the mid teens to over 21 as of Fridays close, just under its upper Bollinger Band, bands which are squeezing. We are now at 3 years + in terms of the duration of this bull market. The biggest IPO in history just came public and with it a large amount of capital was sucked out of the coffers of the investing populous that is now no longer available to support other stocks.
Another dark cloud can be found in the bond stock ratio chart. This ratio is a product of The Goat, Ron Roll, GTOTOY (yes he has many monickers) of DTBC.com .In short the ratio has crossed and and in the past such crossings when held have resulted in significant declines in equity prices. I'm not calling for a bear market, in fact I believe a bounce is close, but and it is a big but, I believe that the above factors, the amount of room the VIX looks like it may have to the upside make this a period of time when some really nasty things are more than possible. After that, it's possible, likely even that we continue on our merry way upwards as the 2009 bottom may well be generational. So...


Last week i sold some strangles in GS and Iron Condors in AAPL & XEL. After looking at the possibilities this weekend, Im not comfortable with those positions. I will be covering and or making adjustments on them this week. I think they more than likely will be profitable if left on, but the risk reward isn't where I would like it to be.

One last question..... Do you think that old man has popped that little blue pill again?

PS I have no affiliation with either Ron, DTBC, Adam or Schaeffers. It is only by standing on the shoulders of giants that I can see further!