Observations and Insight

What a difference a few hours make. If there was a clear theme to yesterday’s newsletter, it was the question, “how low will volatility go?” The reasoning was simple. First, the market bounced so fiercely off the October scare, and has been grinding higher ever since, that it has looked as though there was no end to the resilience of the U.S. market.

Second, the holidays are approaching, and one thing I learned the hard way about trading options around the holidays is that I did not want to be caught long premium. Intraday ranges tighten up. Every weekend means three or four days of empty decay.

The final reason for yesterday’s view that no level is too low for volatility resulted from the release of Buzz Gregory’s volatility forecast. Gregory, Goldman Sachs’ “Oracle of VIX” forecast a VIX reading of 10.6 by the end of the year, which would put it close to the year’s all-time low of 10.28. Article after article yesterday seemed to take Gregory’s projections as a certainty, such as this excerpt from a Barron’s article (view it here => http://jlne.ws/1ziqSgs ):

“Imagine how much money can be made if you know today that the CBOE Volatility Index will be 25% lower tomorrow.”

At the risk of saying “I told you so,” I did include a comment below the story cautioning that it is easy to forecast by extrapolating a current trend into the future, but much more difficult to spot the end of a trend and the beginning of a new one. I did not have long to wait for vindication. Early this morning the market suddenly decided that Greece’s economy is a shambles and the nation has no good options left, and that China’s economy is no picnic either.

So the VIX, after falling steadily for two full months, rallied 12 percent after we published yesterday, and opened up another 12 percent today. All told, the VIX started the week around 12 and has traded as high as 16.68 today.

Next week should be interesting. Will the market again show its resilience, bounce back and allow us to drift back into holiday mode? Or has the trend shifted back? Let us consult the oracle.


Clear Skies Ahead: Terry Duffy of CME Group Says Clearing Is Industry Driver

With the bulk of US financial reforms now in place, financial markets appear to be pulling out of their doldrums. Terry Duffy, executive chairman and president of CME Group, spoke with Jim Kharouf, editor-in-chief of John Lothian News, about his outlook for the exchange and the strong prospects for growth in the futures markets.

“The industry is really exciting right now,” Duffy said. “We’ve been going through some difficult years like all financial markets have. Now we’re getting some clarity around the rules especially here in the US and that’s very positive.”

Duffy said CME Group stands to gain from the migration of OTC trades onto exchange platforms with centralized clearing, especially in the wake of new rules and capital requirements for banks in Europe.

Watch the video »

Lead Stories

VIX Spike Sends Shot Across the Bow
Chris Dieterich – Barron’s
Keep an eye on the VIX or it just may bite you.
While the S&P 500 fell a modest 0.7% on Monday, the CBOE Volatility Index is jumping, up 20% to 14.18 in recent trading. Earlier, the VIX was flirted with its highest close in a month. That’s a big jump in volatility on a day when stocks are only edging lower.
***SR: At the time of publishing this newsletter, the VIX was at 15.36.

Hedge Funds Bet That OPEC-Led Oil Rout Is Near End
Moming Zhou – Bloomberg
Hedge funds are betting that the oil-price crash is close to ending.
Speculators boosted their net-long position in West Texas Intermediate crude by 14 percent in the week ended Dec. 2, the most in 20 months, U.S. Commodity Futures Trading Commission data show. Short bets contracted by 15 percent as long wagers expanded 4 percent.
***DA: Well, they have been wrong so far; last week ended with front month WTI around $70 and traded below $63 yesterday. CME WTI options volume on Dec 8 was 183,124 contracts, well off the Dec 1 volume of 351,186.

Cubist options unusually active before Merck deal
Saqib Iqbal Ahmed – Reuters
Cubist Pharmaceuticals Inc options had one of their most active weeks this year last week ahead of Monday’s announcement that Merck & Co will buy Cubist for a hefty premium.
One series of trades on Thursday appears to have generated at least a 10-fold windfall profit on paper.
***DA: Meh. I’ll put my money on the Impressionists any day.

Stop the ‘Momentum’ Abuse
Adam Warner – Schaeffer’s Investment Research
Momentum — the concept is very real. Plenty of day traders and investors incorporate it into their strategies. But it’s a word that often gets misapplied and misused. Ever watch a football game and hear the announcers say the word “momentum”?
OK, that’s a trick question. It’s impossible to watch a game without hearing “momentum” spit out. Unfortunately, it’s used incorrectly about 99.9% of the time. And yes, it drives me nuts.
**JK – The only options story ever to use the Baltimore Ravens and Miami Dolphins as an example.

Skipping Around: Of Jobs, Oil and Markets
Bob Lang – CBOE Options Hub
Today, we’ll take a look at how jobs, oil and market volatility are playing a role in the market environment.
A Solid Jobs Report:  But You Can’t Please Everyone
Last week’s job number took many by surprise.  What a great report it was, 321K jobs created based on the latest survey, previous reports revised upward.  Yet, all I heard were complaints – the jobs created were temporary, not high-paying career type positions and that this will turn tail in a couple of months.  I disagree with all of this noise.  First, any job creation is great for the economy, and those who have been sitting around waiting for a job are finally getting their chance.
**JK – “OPEC controls supply but does not control demand, and therein lies the issue.” Fracking folks might disagree with that.

Can The Nasdaq Comp & Russell 2k Give The Next Boost? – Weekly Market Outlook
Price Headley – CBOE Options Hub
Though the market may have gotten off  to a bad start with Monday’s 0.7% stumble, the bulls took charge again the very next day to hammer out a gain for the week.  Granted, it was less than a 0.4% gain when all was said and done, but a gain is a gain.
On the other hand, it didn’t take long after last week’s turnaround from Monday’s dip for the lethargy to set in again (some of which is likely due to the winter holiday season).  Once again, the S&P 500 (SPX) (SPY) is bumping around new-high territory, but failing to clearly move above this area.


ICE Sells Remaining Euronext Stake, Profiting From 23% Rally
John Detrixhe – Bloomberg
Intercontinental Exchange Inc. sold the last of its shares in Euronext NV (ENX), completing its exit from a business that has rallied 23 percent since its initial public offering in June.
The Atlanta-based derivatives exchange raised 96.8 million euros ($119 million) by offloading 4.2 million shares, or about 6 percent of the European company, according to a statement today. Euronext gained its independence from ICE through an 845 million euro IPO in June.

Regulation and Enforcement

New Law Would Make Taxpayers Potentially Liable For TRILLIONS In Derivatives Losses
ETF Daily News
If the quadrillion dollar derivatives bubble implodes, who should be stuck with the bill?  Well, if the “too big to fail” banks have their way it will be you and I.  Right now, lobbyists for the big Wall Street banks are pushing really hard to include an extremely insidious provision in a bill that would keep the federal government funded past the upcoming December 11th deadline.  This provision would allow these big banks to trade derivatives through subsidiaries that are federally insured by the FDIC.
***DA: Taxpayers pay one way or the other. The alternative would be for Citi to raise its ATM fees to $25,000 per withdrawal.

If Treasuries Are Manipulated, Good Luck Finding Any Cops
Matthew Leising – Bloomberg
The last time regulators took a hard look at how Wall Street trades Treasuries, a little company called Google Inc. was just starting out.
That was 1998, and the technological leaps since then — including ones that are now transforming bond markets — have left government overseers in the dust. In particular, executives from three of the biggest market-making firms say an electronic bait-and-switch tactic known as spoofing, which is already the focus of a manipulation allegation at a futures exchange, needs to be investigated in cash Treasuries.


Key Indicator Suggests Chinese Stocks Will Rise
Steven M. Sears – Barron’s
Until recently, many investors largely viewed China as an indicator of global demand and output. As long as China’s economy continued to grow rapidly, investors could use demand trends to trade everything from commodities to U.S. government debt.
Now, investors are increasingly interested in direct plays on China.

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