Friday, June 27, 2014

Massive Volatility Shift VIX & S&P



A ‘doji’ is a single period candlestick that has same opening and closing levels.  A single session ‘doji’ is not terribly uncommon, though on future contracts such as the E-mini it is less frequent.  There has only been 44 single session doji on the rolling front E-mini S&P since May 25, 2001 (nearly 13 years).  In other words only 1.3% of the daily sessions since mid-’01 have been true doji sessions.  Over that period there have never been consecutive daily sessions where doji have formed.  We call two doji in a row, not so strangely a ‘double doji’. 

In general a doji, like other small body sessions, indicates indecision and is cautionary against prospects for trend maintenance. It signals a possibility of a trend change.    Because the trend in S&P has been bullish, the sighting of a doji is doubtless a caution of a possible trend change from bullish to bearish.     



A double doji does not give greater emphasis to the warning of trend change that a single session doji affords.  Instead, a double doji suggests an increase in forthcoming volatility.  It is recognized more for its coiling characteristics than for trend change warning. 

Of course, volatility in S&P (shown by the VIX) is near historic lows.  There has been much written about the reason for low volatility present in many of today markets and much of it foreboding and centered around the notion of callous indifference to risk.  As far as the VIX and S&P are concerned, my long held view has been that a closure of the a ‘bullish window’ in the VIX from mid-March ’13 would usher in a protracted period of grinding marginal equity gains over the coming 12-18 months.  That bullish window closure happened exactly one month ago on May 27.  



If ESU settles today at 1948.25, I would suggest that the odds for a near-term volatility event have risen dramatically.  This is not to say that the direction of trade will necessarily be lower.  My inclination is to think that there could well be a very dramatic spike higher.  However, the double doji suggests us not trade directionally, but rather just own volatility. 

Consider owning an at the money E-mini 1950 straddle.  In July with 21 days to expiry it is quoted 3300/3350.  The August with 49 days is quoted 5625/5700.  I reference ESU at 1948.25.  A shorted dated July would be expected to outperform in an immediate development.       

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