To Wait or To Go Ahead, from Victor Niederhoffer

October 23, 2015 |

I would ask an important question. In the marketplace when are the best times to wait?

Jim Sogi writes:

Rocky said mean reverters make a little money a lot of the time, like 99% of the time, but on 1% lose big. Its those big big 100 plus point days or weeks that can cause great harm. Those day you wished you waited to the end of the day, until the next day to buy. Those days you wished you stayed in bed. Is there a way to avoid the ax, the falling knife, the big vol trend down weeks? Is there a warning, a canary to tell you, wait? When 99% of the time it's the opposite?

Our friend Seattle Phil used to say, its all about leverage and max expected draw down. Chair says it's about broker margin games. They're all right of course.

On the days when it's 40 plus down, it seems a bit easier, because you know it can't go much further, normally. The other days that are difficult are the low vol creep upwards week after week.

anonymous1 writes:

The Skew Index provider thinks there is an answer in measuring the market implied probability of an extreme tail event in the stock market. It carries the assumption that the market can evaluate the risk in its assignments of implied volatility up or down.

If it can, then you scale risk exposure levels to match the skew risk measurements. High skew means cut back exposure.

That said, I'd rather know the margin call levels available only to the brokers as a composite readig on all their customers. That can work better than skew for capturing the cleanup prints at the end of the day when increasing margins knock out the risk takers.

CBOE SKEW Index Introduction to CBOE SKEW Index ("SKEW") The crash of October 1987 sensitized investors to the potential for stock market crashes and forever changed their view of S&P 500® returns. Investors now realize that S&P 500 tail risk - the risk of outlier returns two or more standard deviations below the mean - is significantly greater than under a lognormal distribution. The CBOE SKEW Index ("SKEW") is an index derived from the price of S&P 500 tail risk. Similar to VIX®, the price of S&P 500 tail risk is calculated from the prices of S&P 500 out-of-the-money options. SKEW typically ranges from 100 to 150. A SKEW value of 100 means that the perceived distribution of S&P 500 log-returns is normal, and the probability of outlier returns is therefore negligible. As SKEW rises above 100, the left tail of the S&P 500 distribution acquires more weight, and the probabilities of outlier returns become more significant. One can estimate these probabilities from the value of SKEW. Since an increase in perceived tail risk increases the relative demand for low strike puts, increases in SKEW also correspond to an overall steepening of the curve of implied volatilities, familiar to option traders as the "skew".

anonymous2 writes:

Back in 1994, during that memorable Fed tightening cycle, every time the Fed tightened, the market priced in a greater probability of more and faster tightening. Chairman Greenspan referred to the Eurodollar futures market as "A blind man looking into the mirror."

Similarly, I do not think looking at Skew index will help you systematically avoid risk and make money for similar reasons — namely, it is self-referential. At the risk of articulating an Epistemology, any market price that is set by market participants cannot correctly discount the probabilities of something that isn't correctly discounted. I know that sounds like a typo, but it isn't. It's the nature of arbitrage-free pricing.

To say that "high skew means cut back exposure" is way too simplistic and it is what gives rise to the high skew in the first place. It's similar to market participants who adjust exposure based solely on VaR — they take more risk when things "look" safe and reduce risk when things "look" dangerous — with the blessing of academics and statisticians and other wonks. In contrast, many successful investors do the exact opposite: they reduce exposure when things look safe and increase exposure when things look dangerous.

There are many paths to heaven.

Almost no one reading this post has invested a period of protracted 0% CPI or deflation in the USA. I'd suggest that one consider this possibility and its implications — as it is very easy to miss the forest from the trees. The Skew is the trees.

Larry Williams says:

On a different note, seasonality might offer a reason to wait.

Bill Rafter writes:

If you compare SKEW and VIX you can get some good signals that predict the equities market. But those signals are not necessarily better than signals from other indicators. This coeval of signals is simply evidence that when a market is ready to go [fill in your choice, here], its intention to do so is writ wide across the landscape.

If you compare ratios or differences between SKEW and VIX you find that relative to VIX, SKEW is a pussycat. So essentially the comparisons are merely using SKEW as a benchmark with VIX doing the wild dancing. N.B. the series have different orders of magnitude, which means if you want to take their differences you should cumulatively normalize them.

We have always been suspicious of sausage and indices, as one frequently never knows exactly how they are put together. Those newbies studying VIX would benefit from a good understanding of its construction. Dave Aronson (we believe) had similar concerns, prompting his creation of a less theoretical measure of volatility ("True VIX"). The same can be done for SKEW by taking not prices, but ratios of volume and open interest of equity calls and puts and index calls and puts. We have done that and found profitable results, but again not enough to forsake our current algos. However, we have researched the data with the goal of improving equities trading. Someone with the resources to pursue a full blown options program (e.g. a large investment bank) probably would find further study of additional value.

This is our experience to date. We haven't checked everything as doing so is, to say the least, mildly distracting.

Ed Stewart writes:

Anxiety and waiting sucks. How much of winning is just being willing to wear the opponent down, exhaust them. Play the long game to when when no one else sees it. In markets but also business. It seems easy, but if you play that "long" game, everyone else thinks you are an idiot for along time, asking why, up to the moment you win. Then they get it, see you won, but don't see how. They say, "it was luck". That is why it's difficult. One needs to value results over accolades.

Comments

2 Comments so far

Bill Posters on October 17, 2015 7:01 pm
On Friday the S&P 500 close of 2033 is exactly a Fibobacci 2/3 retrace. Enough said already.
brustvergrößerung on November 12, 2015 1:41 pm
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