Morning Audibles 8.3.10 - Tell the DJ to fix it in the VIX

Last evening, I read, perhaps the most interesting BLOG exchange that I've ever read... I'm just going to post the most interesting parts (and let readers here - decipher)... But first, you'll need a little MUSICAL HELP (Amen - I KNOW you "DJ'ed" like CV back in the day so don't lie and say you don't appreciate this)...

"Just tell the DJ to fix it in the VIX"

Goldman Sachs (stated position) - Recommending a short Sep 2010 VIX position

"We are recommending a short September 2010 VIX position, currently near 27.50, with a target of 22 and a stop of 30. We view this trade as a way of trading continued compression in elevated risk premium in a “carry-positive” way, above and beyond any directional view on the business cycle (though there are certainly elements of that here too)."

Before you dabble further, first, remember THESE...

Goldman top trades for 2010:

The full list of nine trades was originally sent to clients in December 2009. [how they're doing]

- Stay short S&P 500 Dec10/Dec11 Forward Starting Variance Swap, opened at 28.20, with a target of 21, now at 30.38. [loss]

- Stay long Russian Equities (RDXUSD), opened at 1645.9 for a target of 2050, now at 1631.95. [loss]

- Stay long GBP/NZD, opened at 2.29, with a target of 2.60, now at 2.1606. [loss]

- Close short 2-yr GBP swap rates vs. long 2yr AUD swap rates on a 1yr forward basis, opened at 268.5 bp, for a potential loss of 24 bp (inclusive of carry). [loss]

- Close short 2-yr TRY rates through cross-currency swaps, opened at 8.77%, with a target of 12.0%, for a potential loss of 168 bp (inclusive of carry). [loss]

- Close long 5yr credit protection in Spain vs. short 5yr credit protection in Ireland at 13 bp, opened at 70 bp, with a target of 20 bp, for a potential profit of 2.9% (inclusive of carry). [profit - whadda ya know]

- Stay long the GS FX Growth Current, opened at 103.5, with a target of 111.8, now at 104.45. [profit, on Goldman's own index - this is like betting 50%+ pass in the Euro stress farce]

- Stay long PLN/JPY, opened at 32.1, with a target of 37.5, now at 28.4298. [loss]

- Stay long Chinese Equities (HSCEI), opened at 12616.01 on 01 Apr 2010, with a target of 15000, now at 12140.5. [loss]

Squid says... (on latest)

"Positioning for risk compression has been a key element of our trading stance across asset classes recently. The details of Europe’s stress test exceeded expectations in terms of disclosure and the resulting signs of easing in funding stresses in the financial sector have helped to reduce risk premia in fixed income and sovereign credit markets. US equity vol has come in a fair bit too, however the volatility curve remains upward sloping,
with the term structure at the very front-end particularly stretched by historic standards; September is trading about 5 points above spot as detailed in the August 2 “The Buzz: Views on US Index Volatility.” In addition, after a long stretch of US data disappointments this month’s PMI reading suggest that the global industrial cycle remains firm, even if evidence of further acceleration is muted. We suspect that markets are becoming more accustomed to the second-half slowdown notion, and now, even moderate signs of stability may also help to keep reduce risk perceptions.

However, the economic backdrop is softening despite a US PMI that beat expectations and similar “strength” in many parts of Europe. The US Economics team has highlighted the possibility that they will lower their GDP forecast for 2011, as domestic demand in the US remains sluggish and risks of muted policy responses are a headwind. These concerns may make realized and/or spot VIX sticky at current levels even as other  forms of risk are mitigated, which is why the premium embedded in the September contract (relative to spot) helps to enhance this trade relative  to a pure market long.

Shorting volatility has been a dangerous trade this year. We remain short forward variance as a Top Trade, with vol levels too high versus likely outcomes. But long-dated vol spiked sharply during May and June and has retraced slowly. One advantage of the near-dated VIX contracts for  tactical trades is that loss-limited strategies through options are available."

-- COMMENTARY --

It's August and everyone is on holiday, nothing happens intraday (see today, dull dull dull) so the vol term structure steepens, and forward vol goes up. This happens every year.

Selling it is maybe not a bad idea, as long as you close it at the end of August, when everyone is back and before vol rallies again as everyone gets nervous about the traditional September/October collapse. You have to get in and out.

But target 22? Dont make me laugh. Target 24, absolute minimum. And GS will get you in sub-27, guaranteed. So IMO maximum 3 points to gain.

Stop loss at 30?..... ah well. Here is where GS make $. What are the chances of something blowing up and the forward vol going up 2.5 points at some point in the next month? Lets say, generously, only 30%.

So GS has a 30% chance of collecting the whole bid/ask spread from you, in and out, and especially out when you call with your book on fire and your boss in your face asking you why you listened to those fucks at GS.... your stop may be at 30 but you will be out at 32.

So 30% chance you lose 5 points, paying GS say 2.5 in stressed bid/ask.

Say 50% chance you make fuck all and have to close it in september, pay GS 1.2 in normal bid/ask.

20% chance you make your 3 points, and pay GS 1.2 to get in and get out.

Full disclosure - am long vol, and in a past life I have made VIX option markets. It is consistently a very very lucrative business. No manipulation necessary, just clients who believe.

Tricky one without much information. One thing I can maybe profitably talk about is the term structure of volatility.

---

Where various regimes signify different economic stresses, if you replace the term rate with the par variance swap level, you have the variance term structure curve. What your friend may have done is

a) found expensive point(s) on the curve to short - a short vol trade, earning theta as you say.

b) sold forward variance (no spot gamma, no theta)

c) or sold a steepener/flattener (some residual short spot gamma, earning some theta)

These are all bank and hedge-fund strategies, not for individuals, as I believe bingocat correctly pointed out above, just thought you might like to see how the traders think.

---

"Vix is probing lower bollinger band (usually provokes a snapback)." 
CV adds (be careful - correct, but WEEKLY lower BB's on VIX are more reliable - McHugh would agree I'd believe)...

"AJC getting press again pimping her SPX 1,300 year-end call (we all know what happens here)"
CV adds (LOL - Rarely hurts to fade AJC)...

And GS is screaming short vol? I'll take the other side of that trade...

---

One should get college credit for reading that string... Now... ON TO the eclectic aspects...

OK - So CV had to whip out the MIDNIGHT STAR to roll his point across... But little do you all know that there is INSPIRATION to every move (which becomes a move - which becomes ANOTHER move [perhaps even more than 15 years later])...

So... You saw the MIDNIGHT STAR "No Parking" clip before... Which was a "Universal" concert that CV happened to be at attendance at (in his EARLY DJ years)... But The following is what they were REALLY famous for (note: I apologize for the sound quality on both - but I've been searching for YEARS to find YOU TUBES on these performances and JUST found them)...

FREAK-A-ZOID

Now I know... That video & sound quality is horrible... But I've been looking for a clip on that performance for the past 25 years - and just found it... What sucks is that the YOU TUBE actually cuts out 2-3 minutes before the end of the performance... But the performance was UNBELIEVABLE... You don't even want to know... BELINDA LIPSCOMB, in her day, would FRY "Beyonce" in a millisecond...

Anyway - I don't want to even get locked onto that... ECLECTIC - is the THEME of this thread... What did it all lead to? Why is that of any importance in 2010... And with the VIX, for crying out loud?...

Well... Let's take a step back... Remember "VIX" rhymes with "MIX"... I kno - kinda cheesy... But MIDNIGHT STAR (and their "unbelievable" performance skills - IMO, equal to George Clinton & Parliament)... Led me to the following young woman...

MADONNA

I think many of you on this blog already know CV's "brush" with the material girl... It wasn't for long... 1986-1988'ish... But it wasn't without episode...

She (TMG) was doing WHO'S THAT GIRL, in 1987 (and had to do a World Tour)... FRANKLY - At the time, she had had a few "hit" singles, but THE WORLD hadn't really caught on yet... You have to think that this was a time, PRE SEAN PENN, that she was still renting a penthouse West Hollywood apartment, and CV spent half his time tossing her damn panties off the upholstery of that apartment to find WORKOUT room... (Note: CV IS NOT the personal trainer that EVER made her pregnant - that was the OTHERS)... But (CV rolls eyes)... she was a head-case...

Anyway - She has to do this World Tour in '87 (and CV has to get her in shape)... Fact is... She didn't NEED to be in shape... She WAS... If I'd have suggested ANYTHING (and of course, I DID)... She needed to work on her LUNGS... She had NO STAMINA to sing LONG SETS, or EXTENDED SONG RE-MIXES...

As always... She KINDA listened to me... and she MOSTLY didn't (which is why we eventually parted ways)...

But LATER... Less than a few months after... After I'd sat up for hours and expressed my opinion on something... THE FOLLOWING occurred...

INTO THE GROOVE (Live) - Torino, Italia - 1987)

This "rendition" was performed in Japan/US/Canada/& Europe in that year... But by the time it had been "polished" in Europe, it had taken on EVERYTHING that CV had intimated from the very beginning...

POINTS?

- CV "hated" the idea of of the silly Michael Jackson kid (it was "patronizing")... whatever
- Madonna HATED singing "Into the Groove"... It was a lung buster (chord wise) She wanted to keep it under 4 minutes...
- CV said... "It was the BEST SONG IN THE SET"... Milk it...
- Madonna COULDN'T SURVIVE (physically) a concert without that song coming in under 4 minutes...
- CV "recollected" a studio version of "ITG" on the YOU CAN DANCE (ep)... Which had sparse sales (other than for DJ's)... Remember - The Material Girl was only interested in CV because he was a TRAINER & DJ at the same time)...

SOLUTION?

CV "suggested" that ITG be extended out to 8+ minutes (on stage)... (Which Madonna didn't have the lungs for [see it in the video - for reference - THE BREAKS - you'll see])... Also... As CV "hated" the MJ kid (and frankly would have NEVER used him - but that was just IMO)... CV suggested that TMG used other FILLER...

FILLER is only "time" (in performance terminology - for all we know - the SPX is doing EXACTLY that right now in this MELT UP - "filling time")...

So... I'd suggested TWO things...

#1 - A MOVING STAIRCASE... (The level of stairs - where a "tapis roulant", treadmill, is located... CV showed TMG how to "DANCE" on that thing)... She learned pretty quickly :-)...

#2 - A BUNCH OF BULLSHIT... For 4 minutes in the video (to save TMG's lungs)... all she needs to do is do a bunch of PARTY S*** back and forth across the extended stage... CV takes NO CREDIT for this wellspring of creativity because it was COMPLETELY inspired by the aforementioned MIDNIGHT STAR concert... Which, in turn, was most likely COMPLETELY inspired by GEORGE CLINTON & PARLIAMENT...

That's the way it works people (if you're ECLECTIC enough to be FLEXIBLE)...

I have to say that TMG (despite our mutual HATRED for one another) to this day... Was "the girl" that UNLOCKED a bounty of success for CV (in Italy), for more than a decade to come (CV "thanks" her for that)...

So all CV can say is... "VOLATILITY IS WEIRD"... Go ahead and take your chances on it if you wish...

It's NEVER disappointed me personally :-)...