JLN Options: Panic Defused in Stocks With Sharpest VIX Drop Since 2009; All the Markets Need Is $200 Billion a Quarter From the Central Bankers; Hedge Funds Were Caught On The Wrong Side Of Two Big Trades Last Week

Oct 22, 2014

Observations and Insight

Michael Gorham, professor and director, Illinois Institute of Technology – How to Regulate When You Don’t Really Understand the Industry

“There’s a lot of problems out there; there’s global warming, there’s the whole Ukraine thing…and then there’s the issue of getting better regulators.”

Michael Gorham, professor and director of IIT Center for Financial Markets at the Illinois Institute of Technology, discusses the regulatory environment in the financial markets. Gorham explains problems regulators have in the industry today and why there are still many things in the industry that the regulators do not understand, such as the issue of Dodd-Frank. He also discusses disruptive and positive forces in today’s market structure, as well as the CFTC’s Technology Advisory Committee (TAC) and what key problems the TAC handles.

Watch the video »

Lead Story

Panic Defused in Stocks With Sharpest VIX Drop Since 2009
Callie Bost and Eric Lam – Bloomberg
The panic has subsided.
Four consecutive advances in the Standard & Poor’s 500 Index (SPX) have pushed the gauge up 4.2 percent since Oct. 15, recouping half the losses from a selloff that began in mid-September. After surging to a 28-month high last week, the Chicago Board Options Exchange Volatility Index (VIX) has fallen at least a point a day starting Oct. 16, reflecting a dissipation of investor concern that hasn’t occurred in five years.
***JB: Nothing to see here.  Move along.

All the Markets Need Is $200 Billion a Quarter From the Central Bankers
Simon Kennedy – Bloomberg
The central-bank put lives on.
Policy makers deny its existence, yet investors still reckon that whenever stocks and other risk assets take a tumble, the authorities will be there with calming words or economic stimulus to ensure the losses are limited.
A put option gives investors the right to sell their asset at a set price so the theory goes that central banks will ultimately provide a floor for falling asset markets to ensure they don’t take economies down with them.
***JB: Well if that’s all…

Hedge Funds Were Caught On The Wrong Side Of Two Big Trades Last Week
Myles Udland – Business Insider
In a new report, Societe Generale gives an update and an overview of how hedge funds were positioned during the recent volatility, and overall, they were a little caught out.
As SocGen simply puts it: “Hedge fund expectations of rising US bond yields, implemented through short Treasury positions and long dollar trades, left them maximum exposed in the correction last week.”

New Tools for Options
Theresa W. Carey – Barrons
Alibaba Group Holding’s huge initial public offering has spurred fresh interest in the U.S. options market. Although Alibaba has been trading for just a month, its options were recently the 12th most actively traded of some 3,600 listings, with many traders rushing to place bullish bets. According to the Options Industry Council, 71.9% of Alibaba options are calls, with the remaining 28.1% on the put side, a clear vote of confidence in the stock of the e-commerce giant.

Bullish bets on QQQ, SPY ETF options bank on new market highs
Saqib Iqbal Ahmed – Reuters
Record-low prices for some bullish options on two of the largest U.S. exchange-traded funds appear to have lured one investor to place a big bet that U.S. stocks are headed back for all-time highs within the next four weeks, options analysts said Tuesday.
The two big bets were placed within minutes of each other Tuesday morning on the options of the SPDR S&P 500 ETF (SPY.P), which tracks the benchmark S&P 500 Index .SPX, and the PowerShares QQQ Trust (QQQ.O), which follows the Nasdaq 100 .NDX.

Derivatives Volumes Plunge in First Half of 2014
Mark Melin – ValueWalk
Lack of volatility blamed in first half, while single stock futures is the cleanest dirty shirt in the group
For the worldwide derivatives industry, the first six months of 2014 was like eating a stale, soggy potato chip: disappointing and boring.
With market volatility in check most of the year, Global futures and options volume sank by 14 percent, according to a report by Futures and Options World. During the first half of 2014 only 9.7 billion contracts were traded compared to 11.2 billion during the previous year over year period. The drop marks the lowest volume since 8.2 billion contracts were traded globally in 2009, a period before the Chinese futures market provided a major contribution to volumes.

Here’s why the stock market melted up
Bob Pisani – CNBC
Stocks rally big. Why the melt-up? Some of this may be hedge fund desperation.
It’s odd, because on the surface there is really no reason for the Dow Transports to be up 3.1 percent, or the NASDAQ to be up 2.4 percent, or the S&P 500 to be up 1.9 percent.
Oh, I know the story, I’ve been saying it for the last two days: 1) Fed is perceived to remain dovish, along with the ECB, which will start to get creative with expanding its balance sheet, 2) oil has stabilized and 3) Ebola fears have eased.
Does this mean the coast is clear? Of course not.

Fragility bigger worry than volatility
Rob Cox – Breakingviews
It has been impossible to escape the V-word for the past week. Turn on the television, and it is easy to conclude that central bankers, corporate chiefs, investors and politicians think volatility is the biggest problem vexing global markets. The rollercoaster ride recently experienced by financial assets is nettlesome. But it’s merely a symptom of a bigger malady: the fragility of widely accepted assumptions about where the world is headed.

Russell Investments Small Cap Compendium
Russell Rhoads – CBOE Options Hub
Russell Investments just released the inaugural edition Small Cap Compendium which going forward will be a quarterly publication. The Small Cap Compendium brings together a variety of market participants that focus on the small cap sector. I was honored to be asked to contribute to this first edition with a discussion of the CBOE Russell 2000 Volatility Index (RVX). The first edition also includes articles from Stephen Wood and Scott Maidel of Russell Investments along with Lori Calvasina of Credit Suisse.


Binary Options Now Have Their Very Own World Championship Co-sponsored by Nadex
Vasil Velev – Forex Magnates
The North America Derivative Exchange (Nadex), the only binary options trading exchange which has legal clearance to operate in the US, is co-sponsoring an aptly named World Championship of Binary Options.
The tournament is currently gathering participants and will run for one month, starting from November 2nd and ending on the 28th with a rather low entry bar of a $500 balance requirement. Participants can join in at any point of its duration. The prize worth however, has not yet been published.

Regulation and Enforcement

Fed spotted JPMorgan ‘Whale’ risks years before scandal: inspector
Jonathan Spicer and Michael Flaherty – Reuters
The Federal Reserve’s New York branch knew about risks JPMorgan Chase & Co was taking with its massive “London Whale” derivatives bets four years before they imploded, but it failed to act properly to head them off, the U.S. central bank’s inspector general said.
The Fed’s Office of Inspector General said on Tuesday one of the key flaws it uncovered in its probe of the 2008 transaction at the Wall Street bank was the New York Fed’s over-reliance on certain personnel who left the supervisory team in 2011. That created a “significant loss of institutional knowledge” within the team assigned to inspect JPMorgan, the report said.


Calculating the New VIX—the Easy Part
Vance Harwood – CBOE Options Hub
The movements of the CBOE’s VIX are often confusing.  It usually moves the opposite direction of the S&P 500 but not always.  On Fridays the VIX tends to sag and on Mondays it often climbs because S&P 500 (SPX) option traders are adjusting prices to mitigate value distortions caused by the weekend.
In addition to these market driven eccentricities the actual calculation of the VIX has some quirks too.  The VIX is calculated using SPX options that have a “use by” date.   Every week a series of SPX options expire.  This schedule of expirations forces a weekly shift in the VIX calculation to longer dated options.  For many years the CBOE’s VIX calculations only used monthly SPX options, but starting October 6th, 2014 it switched to using SPX weekly options when appropriate.  See “Why the Switch” section towards the bottom of this post for more information.

Options Education

Why Pre-Earnings Options Pricing is So Imprecise
Adam Warner – Schaeffer’s Investment Research
Our streak of days with high-profile earnings gaps ended at one yesterday, as Apple Inc. (NASDAQ:AAPL) had a relatively calm reaction to its usual stellar numbers. The options priced in about a $4 move, and the actual opening gap was about half that.
There was a long volatility “win,” however, as The Coca-Cola Company (NYSE:KO) — of all names — was a serious disappointment. It wasn’t the biggest score ever, though, for the options owners. The board priced in about a $1.20 move, and in actuality it gapped down about twice that.
All of which leads me to realize I better refresh what it is we’re talking about here.

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