VTS Community,

Given that the S&P 500 has broken the all-time record for the longest streak without a 3%, 5%, and 7% correction, it’s only natural that traders are looking for any weakness at all as a sign that we’re finally going to see markets take a breather.  I remember there was a lot of chatter in the blogosphere and on Twitter on the last day of 2017 because it was actually a pretty weak final hour of trading to end the year.  A lot of people were saying that was the beginning of things to come.

Well not only has the S&P 500 not started it’s long overdue correction yet, but it’s actually just accelerated and gone parabolic so far in 2018.

Here’s a 20 year chart of the S&P 500, and you can see the Relative Strength Index  (RSI)  is so comically high it should be wearing clown shoes at this point.

 

 

The S&P 500 is up 7.45%, but something that has really taken a lot of trades by surprise is that volatility products are not following suit.  You can see here the SVXY  (in green)  is barely positive this year:

 

 

The last 18 months or so has conditioned many newcomers to the volatility space to think that volatility products are just leveraged S&P 500 products but this just isn’t true.  It’s very cliche to say but worth repeating:

Correlation does not imply causation

Just because inverse volatility products are correlated to the S&P 500 does not mean they track it.  There is no causation there and they can and do sometimes break away from each other.  Remember my previous article volatility is non-directional, it can go up when stocks go up.  It’s vital to understanding their movements to know that the volatility products derive their price based on VIX futures, not stocks.

 

Is SVXY broken this year?

Not at all and in fact it’s poor performance so far this year is explained if we look to the actual source of it’s net asset value:  VIX futures.  Short end inverse volatility products like the SVXY derive their price based on a rolling of the first two months of the VIX futures.  Depending on how many days are left in the monthly cycle, the weighting of 1st and 2nd month changes.

Here’s M1 & M2 represented as a rolling 30-day maturity future:

 

 

To start the year this constant maturity future dropped which is why the SVXY was doing well at the start of the month.  However here we are at the end of January and we’re actually higher than we were a month ago.  This is why SVXY has not performed well.

This can change quickly though and there’s definitely some room for the VIX futures to come down a little bit, but as of now the volatility market has been holding firm at these levels.  It’s likely just normal hedging activity to be expected when markets see extreme valuations, but we’ll keep an eye on things and always be ready to move in or out of positions on a single day notice.  That’s one of the keys to our long-term success, not getting married to any positions we hold.  We’re in if the math supports it, but we will move to safety when necessary.

 

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