It’s A Trader’s Market Now

February volatility has clearly signaled a regime change. We’re no longer in a market that rewards ‘hodlers’ to think less and hold more. It’s a traders market now.

The S&P finally snapped that ridiculous no pullback streak we’ve all been watching on Fintwit. (Picture below via Bespoke.)

And that break caused the largest short volatility unwind in the history of the VIX complex. The one day move on February 5th set records for the largest point move and percentage move in the VIX index. This includes data from the 2008 financial crisis.

This up move caused the VIX futures term structure to trade at levels last seen in the 2008 financial crisis.

Now the big question is whether or not this volatility will persist. Will equities work off the uncertainty and resume the 2017 uptrend? Or will 2018 look like a giant volatile and choppy range?

We’ve found it extremely helpful to watch the trend in credit spreads to determine the forward vol regime. When credit spreads widen volatility in the market will persist and stay high. When credit spreads tighten the opposite occurs — volatility comes down.

A quick way to check out credit spreads is to plot the ratio between SHY and HYG (SHY/HYG).

Credit spreads are on the precipice of breaking out and reversing the down trend from 2015. If this chart can breakout and hold then we should expect more volatility in the months ahead.

Right now it’s sort of in “no-man’s land.” In response, we’ve cut back on our aggressive short vol stuff and have started to move our focus into trades that will benefit if this chart breaks out. This is in line with our macro view that higher volatility is ahead.

Unfortunately, monetizing a forecast for higher volatility is tough. Pretty much anything that benefits from higher vol has a negative carry along with it (short high yield bonds, long VIX calls, long puts on SPX, long VXX etc.). All of these long vol trades slowly bleed you to death unless you happen to get in at the perfect time. It’s possible to do — but tough.

Luckily, there’s an alternative way to monetize higher vol if you’re willing to do some tactical trading. Historically speaking, long only mean reversion systems with one day holds have worked fantastic on equity indices during volatile conditions.

Tactical strategies in stock indices that buy on panic closes, hold overnight, and sell on the next day’s close can harvest a liquidity premium that appears when market participants freakout and dump their exposure.

There’s hundreds of way to write strategy logic that takes advantage of the overnight liquidity premium.

We have access to a genetic algorithm (hat tip to our friends at Build Alpha) that can scan for the top ones. Here’s what it spit out for the S&P.

  • Mon,Tues = 1
  • rateofChange(close,3)[0] < rateofChange(close,3) [2]
  • Stochastics(4) <= 20
  • If true, buy market and sell after 1 day

Basically, it’s telling us to buy when markets get really oversold on Monday or Tuesday and then to sell on the next day’s close.

The graph below shows the equity curve for the strategy all the way back to 1998. Performance has been strong throughout time — and the strongest during 2008.

That highlighted part of the equity curve on the right is the performance of the algo on “out of sample” data. When using a genetic algo it’s important to make sure you test it on unseen data to make sure it’s robust. The fact that this logic has continued to perform on unseen data is a great sign. It means the overnight liquidity premium in volatile conditions is real and not some spurious relationship dug up by a machine.

The next plot shows a breakdown in performance per year.

2002 did fantastic. As well as 2007-2008 and 2014-2015. All of these periods were characterized by high volatility and choppy price action — the exact type of environment were expecting in 2018.

The above trading strategy can be executed on either the SPY ETF or the E-mini S&P 500 futures.

Consider adding this tactical trading strategy into your trading book this year especially if credit spreads breakout and hold.

The above was an excerpt from our Macro Intelligence Report (MIR). If you’d like to learn more about the MIR, click here.



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Brandon Beylo

Value Investor

Brandon has been a professional investor focusing on value for over 13 years, spending his time in small to micro-cap companies, spin-offs, SPACs, and deep value liquidation situations. Over time, he’s developed a deeper understanding for what deep-value investing actually means, and refined his philosophy to include any business trading at a wild discount to what he thinks its worth in 3-5 years.

Brandon has a tenacious passion for investing, broad-based learning, and business. He previously worked for several leading investment firms before joining the team at Macro Ops. He lives by the famous Munger mantra of trying to get a little smarter each day.


Investing & Personal Finance

AK is the founder of Macro Ops and the host of Fallible.

He started out in corporate economics for a Fortune 50 company before moving to a long/short equity investment firm.

With Macro Ops focused primarily on institutional clients, AK moved to servicing new investors just starting their journey. He takes the professional research and education produced at Macro Ops and breaks it down for beginners. The goal is to help clients find the best solution for their investing needs through effective education.

Tyler Kling

Volatility & Options Trader

Former trade desk manager at $100+ million family office where he oversaw multiple traders and helped develop cutting edge quantitative strategies in the derivatives market.

He worked as a consultant to the family office’s in-house fund of funds in the areas of portfolio manager evaluation and capital allocation.

Certified in Quantitative Finance from the Fitch Learning Center in London, England where he studied under famous quants such as Paul Wilmott.

Alex Barrow

Macro Trader

Founder and head macro trader at Macro Ops. Alex joined the US Marine Corps on his 18th birthday just one month after the 9/11 terrorist attacks. He subsequently spent a decade in the military. Serving in various capacities from scout sniper to interrogator and counterintelligence specialist. Following his military service, he worked as a contract intelligence professional for a number of US agencies (from the DIA to FBI) with a focus on counterintelligence and terrorist financing. He also spent time consulting for a tech company that specialized in building analytic software for finance and intelligence analysis.

After leaving the field of intelligence he went to work at a global macro hedge fund. He’s been professionally involved in markets since 2005, has consulted with a number of the leading names in the hedge fund space, and now manages his own family office while running Macro Ops. He’s published over 300 white papers on complex financial and macroeconomic topics, writes regularly about investment/market trends, and frequently speaks at conferences on trading and investing.

Macro Ops is a market research firm geared toward professional and experienced retail traders and investors. Macro Ops’ research has been featured in Forbes, Marketwatch, Business Insider, and Real Vision as well as a number of other leading publications.

You can find out more about Alex on his LinkedIn account here and also find him on Twitter where he frequently shares his market research.