The current global macro community is littered with uncertainty; this presents an opportunity for a play on impending volatility swings. The variables that could ignite a volatility move are as follows: Iran nuclear situation, further Euro area developments, US domestic economic data shining a light on the state of the recovery, and further developments from China and its move towards expansionary policy. Those, as well as the unforeseen events, are drivers of future volatility.
The run up of equity since October has astounded many market observers. As is seen below, initially there was volatility off of the October lows, but since then, volatility has been on the decline. At current levels and with the global economy the way it is, volatility looks to be imminent.
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Similarly, the VIX confirms the consolidation of volatility and conveys that even in light of macro developments, equities have not faltered. However, recently, the VIX downtrend has broken and sideways movement has ensued. This signals a potential spike if the SPX were to pull back on correction and fear.
A way to play this may be to put on a bullish option's position in order to capture the magnitude and leverage of the trade. The underlying that would garner us exposure to the volatility move is VXX. VXX tracks the S&P 500 VIX short term futures and would move inversely to an equity pullback.
As for a price target, I like a move to 33 on the VXX chart. The timing factor is hazy, so I am going to buy some time in case an equity saucer top prevails. The position as shown below is to buy an OTM 30 call and sell an OTM 33 call. This makes for a cheaper position and the price movement is by no means unlikely, if not extremely probable.
The P&L table below highlights that any move upward in VXX and subsequent pullback in SPX will lead to profit generation in the short term and in the long term a move to 30.65 is needed.
Another chart to highlight the likelihood of increased volatility is the Credit Suisse Fear Barometer. This index tracks fear in the market essentially, and at its current level of 29.11, is sufficient in predicting a pullback in the SPX.
On a more qualitative level, avoiding the charts, the macro environment warrants fear and uncertainty. This year only around 20% of US companies were willing to issue concrete guidance on the economic environment as opposed to the usual 33.3%. This highlights that even C level corporates lack confidence in their projection abilities for the year 2012. The Iran situation is shaping up to be bullish for oil as their course towards obtaining nuclear capability seems undeterred by mere threats and sanctions. This increases the probability of more direct opposition in the form of ground and air strikes. The consequences of this could be warranted by the long term benefits, but in the short term, domestic consumers will feel the commodity inflation.
As well, government spending will be forced to expense this endeavor for the betterment of society and our safety. The Greece situation looks grim even though bailouts have been further agreed upon. The non sequiturs that the euro was built on will be a hindrance in its success. Primarily, heterogeneous economies cannot function under a singular monetary system. The disparity between necessary and actual interest rates and anti inflation got the area into its current debt trap and continuing to function within the system provides no one with a solution. Only when the system can acknowledge its flaws will it be able to restructure and lead to resolve.
Although the diatribe above concerning potential world threats may seem superfluous, it is completely necessary to convey just how much volatility should be present in current markets. The markets and its players are exhausted from the summer swings, but the pickup of volatility is ever present.
Disclosure: I am long VXX.
