In Large, Red, Friendly Letters, It Reads “Don’t Panic!”

With the long bond, Japanese Yen, Swiss Franc, and option implied volatility rising today, there is a panicky feel to the markets. Though this could be the start of a “big, bad event,” the odds are that it will not be so bad. One signal of panic that I see is that the VIX is up 21% today, against an S&P 500 down 1.5%. Under ordinary circumstances, that ratio is 10, rather than the 14 we are seeing today. if that ratio gets over 20, it is a sign that too many people are buying index puts to protect their portfolios. If it gets under 5, too few are doing so.

And, as with most investing, stick to your normal way of doing business. Don’t overreact to the markets. We haven’t had significant volatility in a while, and frankly, we need some to keep people from speculating overly. Don’t react to today; ask yourself what things will likely be like three years from now, and use that as your guide to investing. The manic Mr. Market may serve up some bargains. If so, my rebalancing discipline will edge me more into the markets, bit-by-bit in a measured way. This takes the emotion out of it, which leads to better overall performance.

Late Update
Sold my TLT positions slightly after 3PM today and bought some QQQQs with the proceeds. I think that the short run selling is overdone, with the TRIN over 14, and my ratio mentioned above, which I call DeltaVIX over 17, I felt it was better to add a modest amount of equity exposure to my balanced mandates. We added some Hartford as well at the hedge fund. None of my broad market portfolio hit a rebalance point, so I didn’t do anything there, despite 32 out of my 35 stocks being down over 1%, and only one up. In aggregate, it looks like my braod market portfolio will be down 3% or so, and my balanced mandates down a little more than a percent.I’ll have more on this later this evening. I plan on reviewing all of my indicators tonight, and see what they suggest.

PS — a friend pinged me and suggested that today’s move in the VIX did not come from put buying, but from options selling. He cited the increased correlation of stocks to one another. I’ll have to think about this some more.


long FXY FXF QQQQ HIG (and apologies to the late Douglas Adams) and now after the update flat TLT

5 thoughts on “In Large, Red, Friendly Letters, It Reads “Don’t Panic!”

  1. Hi David, Could you explain the many possible meaning behind your friends assertion that the vix is up on options writing?

    My guess: folks are writing calls to collect the premium because they feel the pps will go down and stay down. This seems very bearish.

    What’s your interpritation or new data from the vix?

    Thanks, curt

  2. Hi David,

    I was just curious whether or not the events of today will change your thesis that the Fed won’t cut rates in 2007

    a day like today adds some credence to the “risk control” mantra, no?…on the other hand, I’m not sure that those engaging in “low risk, high reward deep in the money call buying” are feeling happy right about now!

  3. Thanks for the update today; no fun; the trading system run for several broker dealers went tilt after 3:00 pm eastern; a major pain

  4. Paul, I’m not sure how we got our trades off today. B of A’s system had a glitch, and we had to reboot our trading sytem at an inconvenient time.

    aliens8mycow — it doesn’t change my FOMC view yet; this is just one bit of data, and if you look at my last CC post of the day, you can see that I think that ties between the equity market and the real economy are tenuous at best. I’ll revise my opinion, maybe, after the GDP report. Surprise that no one is looking for: an increase in the implicit price deflator.

    Curt Smith — I asked my friend for a clarification, and to be honest, I didn’t understand it that well. In hindsight, I should not have posted it. It seems that as stocks have become more correlated, systemic risk is more prevalent. It is possible that my friend meant that as the market falls, players were closing out short call options positions. Now that would make sense.

    But as for the move in the VIX, it was overdone relative to the S&P. I think we get a bounce, though maybe not tomorrow.

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