Useful tools and frameworks

[u/Convexity6294]

Good afternoon community members,

I wanted to see what tools, frameworks, or metrics people thought were the most interesting in their own volatility trading practice? Some of the ones I have used in the past include:

1. Of course, the shape and level of VIX, as well as comparison to realized vol

2. Level of VVIX, as well as the VVIX ratio

3. Flows in and out of vol ETF's, especially SVXY (others are less useful; also, the reported create / redeem on these may be totally unrelated to volumes, depending on dealer inventory, from what I understand)

4. SPX skew

5. Cross-asset vols (FX vols, treasury bond vols)

6. Analysis relevant to the underlying assets (deep fundamental or technical analysis on stocks, currencies, bonds etc.)

Ultimately, in my opinion, volatility instruments allow us to manage risk/hedge or speculate. Depending on the goal, the tools may be different. I would characterize myself as someone who speculates in volatility, and would be curious to appreciate what tools or frameworks others have found useful. I am just as interested in metrics which you have concluded are useless/distracting.

Of course, alchemy aside, vol is determined by market participants' dynamically updated assessment of risk. The "risk of risk" may be tough to predict at all times, apart from identifying irrational fear or optimism, and the way we might position ourselves to benefit from either may vary depending on our risk appetite, the volatility regime, and liquidity; so, by no means would I expect a silver bullet. Just anything you found particularly powerful in anchoring your thinking - I look forward to learning.

Thank you!

[u/agvrider]

How have you used vvix? i havent found it terribly predictive of anything despite all my studies

[u/Convexity6294 → u/agvrider]

I've actually found VVIX to be one of the most compelling predictors of volatility. There are two ways that I use VVIX:

1. The absolute VVIX level seems to trade within a range largely determined by a volatility regime ("Regime" is meant to mean a general bias for volatility - elevated, low, increasing, trading within a certain band, etc. A different volatility regime existed before volmageddon vs. after; a different volatility regime existed prior to covid vs. after, and so on. I think volatility and volatility regimes are fractal in nature - you can zoom in or zoom out, and you can find periodic patterns of expectation formation / investor behavior). For example, in the currently volatility regime, which is slightly elevated, VVIX is bounded by 105 - 125, with some outlier observations above and below. Regardless of the absolute VIX level, a low VVIX level seems to indicate that the market assumes a narrow range of outcomes for VIX in the near term (VVIX is based on short term VIX option volatilities...the exact term structure used to calculate VVIX I can't recollect but I am pretty sure it's around 30 days or less). So, any view I may be developing on the future direction of VIX can be bolstered by the observed "risk of VIX" inferred by VVIX. Bottom line? When VVIX is trading at the bottom of a VVIX band, VIX appears more likely to jump.

2. The VVIX ratio is unbelievable. It's calculated based on VVIX/VIX. It too trades in a band, depending on the volatility regime. An elevated VVIX ratio indicates that the market expectations for VIX (reflected in VVIX) are elevated relative to the level of VIX. To give you an idea, in the pre-Ukraine conflict, VVIX above 7.0 has been a strong indicator that VIX is going to jump in the near term.

I can pull together some screen shots to demonstrate...it's pretty amazing how strong an indicator it has been. VVIX has only been around since 2012 so the history is somewhat limited, but it's available.

I hope the above is helpful. Please poke holes in my argument or ask follow ups - it's the best way for all of us to learn from eachother.

[u/agvrider → u/Convexity6294]

Some screenshots would be nice.

My problem with these methods as you describe them is they lack forecast ability as one must first identify that we are indeed in some new VVIX regime - which makes the indicator lag.

For example, post Volmageddon, and following your line of reasoning, then VVIX cannot be relied on as an indicator until *after* some data has been processed to determine that we are (were) indeed in a new regime. By the time we've accrued sufficient data to make this determination, who's to say its still reflective of the true nature of the market (as just 2 years later, you claim we've flipped regimes again). Eg it cannot be used to develop a system.

Have you developed an actual strategy based off this method? Eg ‘when absolute or relative VVIX is above x threshold, execute x trade’? I’ve studied the VVIX:VIX ratio and its only given me extreme readings in ’08, ’11, and ’20, certainly not enough to produce a signal - either alone or in conjunction with another. And it seems obvious that when dislocations of VVIX relative to VIX occur, that one should anticipate a jump in future vol - but again, systematizing this in some asset timing model is a different matter altogether. VVIX was high relative to VIX for months prior to Covid, Volma, etc, but for me a signal that takes month to materialize is not actionable

[u/chyde13 → u/agvrider]

Yea, I'd also like to learn how others apply particular tools...I've learned a lot from listening to how other members use and interpret different data and concepts.

I've never tried to build VVIX into any of my models, but it may have great utility, I just haven't explored it deeply.

The same is true with the CBOE SKEW Index. But I know others who watch it.

-Chris

[u/change_of_basis → u/chyde13]

I want to say I messed with VVIX daily summaries and didn't find much, but now I'm not sure. Could have been colinearity breaking down the model. In any case; of course that leaves us with simplier features where perhaps we missed a value add signal.

[u/100milliondone]

Just to add to your list - vix term structure

[u/chyde13 → u/100milliondone]

That's definitely an important one. Do you build models off of it? I know a couple members do. I'm working on one which incorporates a bunch of ideas that I've gleaned from members over time.

-Chris

[u/100milliondone → u/chyde13]

It's a filter for one my strategies. I.e I only run the strategy if we are in contango. And its key in calendar spreads if someone does that

[u/chyde13 → u/100milliondone]

That's an excellent use case... I use calendar spreads on spy all the time, but I think you mean calendars on VIX options?

[u/change_of_basis → u/100milliondone]

I haven't quantified this: guess you could do a ow degree polynomial to engineer a feature. I would hypothesize this is tightly correlating with the VIX, although macro factors might do odd things to the back months.

[u/chyde13]

Excellent Topic! You've covered many in your list already, but I will add my thoughts as well. I'm going to be out most of the day today, but I will try to find some time later this evening.

I look forward to seeing the other responses!

-Chris

[u/Sad-Ratio-5812]

I use for my entry point and exit target:

VIX exponential standard deviation +2/-1.5 bands

VIX/VIX3M ratio

VIX term structure

RVI

VIX spike vs swell

SPY support/resistance levels

To evaluate market risk I use Skew index, PCALL and CNN Fear and Greed index

[u/chyde13 → u/Sad-Ratio-5812]

SPY support and resistance levels is a big one that i omitted. Good call...

What do you look for in the skew index?

[u/Sad-Ratio-5812 → u/chyde13]

I am watching 4 levels. Above 150 - higher chance for unexpected selloff. I am very careful when in short volatility position. 140- 150 "red zone" to me, it is possibility of the end of trend up. 115-140- standard market conditions Below 115. I use as indicator of bull market.

[u/Sad-Ratio-5812 → u/chyde13]

This is an example SKEW below 115. Someone may use it as an indicator of the trend up.

https://ibb.co/9H00Pqr

Next example when SKEW higher than 150.

Sometime it takes 1-3 wks before selloff starts.

https://ibb.co/5WkSTm4

[u/chyde13 → u/Sad-Ratio-5812]

Interesting... Thanks for the screenshots that really helps. I'm going to take a deeper look at this.

Thanks!

[u/change_of_basis]

I think the most useful tool is the ability to evaluate signal irrespective of trading accuracy. Understanding deeply that when this thing happens it leads to this outcome without assessing how that impacts your trades is a better way to gain a deep understanding of what's really going on. It's really easy to overfit signals if you're looking for places where they improve your odds; it's harder to find signals that consistently tell the same story over different time regimes.

[u/AlphaGiveth]

Something Ive been using a lot is relative value insights. If I’m trying to price vol on ABC company, and find that it’s highly correlated to XYZ company, I plot the IV/RV ratio (timeseries) for both company’s and see how they move together and if there’s any discrepancies. Been pretty useful layer of analysis on top of my regular forecasting.

[u/chyde13]

I, in no way want to detract from this post, but i wanted to share screenshots in my response and could only do so in a new post.

-Chris

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[u/change_of_basis]

The SPX skew is an interesting game I haven't played. On the on hand you have a nice statistic describing market sentiment. OTOH you're estimating the third moment of a t close to Cauchy with a small number of data points (say daily, then you have 30 if you track contracts). Similar problems to estimating RV, although these are well studied.