“So far, so good” - Optimist falling from skyscraper

Introduction

2013 stock markets started like 2012 stock markets – with a bang. U.S. stock markets kicked off 2013 with a very good 10.7% return. Also like 2012’s first quarter, foreign markets didn’t fare as well, earning only 3.5% in the quarter. If we merely hold onto these gains for the remainder of the year we’ll do fine.

In the following I examine the details of what has been working in global stocks, providing quick insights into market segments that have succeeded and failed.

U.S. Stocks

Smaller value stocks led the way in the quarter, earning more than 13%. By contrast, large core companies earned only 7.5% and large value earned 9.5%. Other than these extremes, style returns clustered around 12%. This has been one of those unusual periods where the “stuff in the middle” (core) has not performed in line with the “stuff on the ends.” I use Surz Style Pure® classification throughout this commentary.

On the sector front, health care and consumer staple stocks fared best, earning 15% and 14% respectively. By contrast, materials earned only 1%, and infotech gained only 6%.

But the interesting details lie in the cross-sections of styles with sectors, as shown in the following heat map. A heat map shows shades of green for “good,” which in this case is good performance relative to the total market. By contrast, shades of red are bad, indicating underperformance. Yellow is neutral. In the table below, we see that the best performing market segment was comprised of mid-cap core companies in the consumer staples sector, earning 24.1%. And the worst performing segment was small cap core in the utilities sector, losing 11.4%. Many quantitative managers employ momentum in their models, buying the “green” and selling the “red.” Fundamental managers use heat maps as clues to segments of the market that are worth exploring, for both momentum and reversal potential.

Foreign Stocks

Looking outside the US, foreign markets earned 3.5%, lagging both the U.S. stock market’s 10.7% return and EAFE’s 5.3% return. Japan was the big story, earning 12.8% in $U.S. The return in Japanese yen was an even more impressive 23%. The Japanese stock market soared in the quarter as the yen was weakening against the dollar. By contrast, emerging markets suffered a setback, losing 2%.

On the style front, core surprised, as it did in the U.S., but core led rather than lagged.
Like the U.S., further insights into market behavior are provided by heat maps, as shown in the following. As you can see, Japan was “green” in almost all styles and sectors, and emerging markets and the materials sector were both mostly red — underperming.

How to Use This Information

We all have outlooks on the economy and the stock market, and adjust our thinking as results roll in. I personally remain surprised and grateful that stocks have performed so well recently. In my end of year commentary, I pointed out Japan as a bargain play, and the movement of assets into emerging markets. As 2013 has unfolded so far, bargain hunting has won, and asset flow has lost. You can use the information above to test your personal outlooks, to see which are unfolding as you think they should and which are not, with the intention to clear the haze from those crystal balls.

This is our first Heat Map blog. We are currently researching patterns and signals that predict the future. Our laboratory is rich and extensive, with over 300 potential indicators spanning two decades. Stay tuned.

In the continuing series of discussing methods of trading the CBOE Volatility Index® (VIX®) futures contract traded on CBOE Futures Exchange, LLC (CFE®), this article will discuss utilizing the Commodity Channel Index (CCI).

In each article, readers are reminded that the liquidity of a trading instrument is always very important. On March 1, 2013, CFE again reported a continuing trend of increased volume in the VIX futures contract. Specifically, February 2013 was the second consecutive month that achieved record average daily volume, total volume and single-day volume for the VIX futures contract and for CFE.i

The average daily volume (ADV) for the VIX futures contract reached a record 161,176 contracts traded. This was an increase of 141% from February 2012 and an increase of 17% from January of 2013. February 25 and 26, 2013 experienced record volume days of 302,278 and 299,566 contracts traded respectively. This was also the first time that the VIX futures daily volume exceeded 300,000 contracts. The previously single-day record volume of 221,323 contracts was set on January 2, 2013. In February 2013, 3,062,344 VIX futures contracts were traded, representing an increase of 129% from February 2012. February 2013 trading represented a 6% increase from the record of 2,897,739 traded contracts set in January 2013. February 2013 was the sixth consecutive month in which trading exceeding two million VIX futures contracts and it was the first month in which trading exceeded 3 million VIX futures contracts.

The CCI was developed by Donald Lambert and introduced in the October 1980 issue of Commodities magazine (aka Futures magazine). Application of the CCI is not limited to physical commodities and may apply to financial instruments as well. The CCI is a metric of an investment’s variance from its statistical mean. The CCI reports high values when a market reaches an extended high price relative to its average price. It will report low values when a market reaches an extended low price relative to its average price. In basic terms, the CCI is an overbought/ oversold indicator.ii

The CCI is based on the premise that all markets have cycles from low to low or high to high. The CCI is calculated by calculating a typical price of the day from the high + low + close and then creating a simple moving average of the typical price. The final equation of the CCI = (typical price – moving average)/ (0.015* mean deviation). Lambert applies a constant of 0.015 to keep 70% to 80% of the CCI value between +100 and -100.iii

The CCI is considered overbought when the value exceeds +100 and is considered oversold when the value is below -100. However the CCI may extend beyond +100 and -100 and the market could remain overbought/ oversold for an extended period of time. If a market continues to remain overbought/ oversold, but the CCI is reversing (divergence appears) it may imply the market is nearing a correction. Some examples of divergence are provided in this article.

Parameters of the CCI are based on cyclical periods of the market. For this article we assumed a 60 day cycle, using a 20 day (1/3 of the cycle) CCI parameter setting. The lower the parameter setting, the greater the probability of the CCI to reach overbought/ oversold values.

Chart 1: Nearest Monthly VIX Futures Chart, 20 Month CCI

In 2012 we discussed methods of trading the CBOE Volatility Index (VIX) futures contract at CBOE Futures Exchange, LLC (CFE). In this article, we will review the previously discussed trading methods and how to apply them to the current market environment.

Liquidity is an important factor for trading. Several times during 2012 VIX futures volume reached record levels including a record high of 2,734,248 contracts in November, Which was a 233% increase from November 2011’s 822,017 contracts and which broke the prior trading volume record set in October by 12%. In November the Average Daily Volume for VIX futures was 130,202, an increase of 233% from November 2011. To date, the November VIX futures total volume is 86% higher than it was in 2011 and year-to-date trading volume is 21,344,285 contracts versus 11,455,871 in 2011.i

In past articles we discussed the use of four VIX futures trading strategies: 1) utilizing support and resistance to seek contrarian changes at range bound extremes; 2) crossing of moving averages; 3) utilizing the Aroon Oscillator; and 4) using the True Range to trade VIX futures. In this article the parameters have been set to the same level as they were set in previous articles.

We begin discussing the support and resistance methodology. We originally discussed this in the September 2012 article “VIX Trading Strategies”. The VIX futures contract historically tends to find major price support between 10 and 15 and it finds major price resistance around 40 (with the exception of the financial crisis). As you will notice in the monthly chart below VIX futures tend to rally after forming a floor at or near a price of 15. This most recently occurred in 2010 and 2011. During the last several months, the VIX contract has once again found the price of 15 to be major price support area. Could this be the foundation of a floor for a rally in 2013?

Chart 1: Monthly Nearest VIX Futures Chart with Support and Resistance
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Copyright ©2012 Mark Shore. Contact the author for permission for republication at info@shorecapmgmt.com Mark Shore has more than 20 years of experience in the futures markets and managed futures, publishes research, consults on alternative investments and conducts educational workshops. www.shorecapmgmt.com

Mark Shore is also an Adjunct Professor at DePaul University’s Kellstadt Graduate School of Business in Chicago where he teaches a managed futures / global macro course and an Adjunct at the New York Institute of Finance.

Past performance is not necessarily indicative of future results.  There is risk of loss when investing in futures and options.  Always review a complete CTA disclosure document before investing in any Managed Futures program.  Managed futures can be a volatile and risky investment; only use appropriate risk capital; this investment is not for everyone.  The opinions expressed are solely those of the author and are only for educational purposes. Please talk to your financial advisor before making any investment decisions.

Continuing the series of discussing various methods of trading the CBOE Volatility Index® (VIX®) futures contract at CBOE Futures Exchange, LLC (CFE), we will discuss the utility of the True Range indicator and the Average True Range indicator. In previous articles we discussed the use of spreading, correlations, moving averages and the Aroon indicator as methods of trading VIX futures.

Liquidity is an important factor of risk management. CFE announced on November 1, 2012, record volume in October 2012 for both the VIX futures contract and total volume of the Exchange. VIX futures reached a record 2,443,878 contracts traded in October 2012, a 172% increase from October 2011 and a 2% increase from September 2012. The October 2012 Average Daily Volume was 116,375 contracts, a 172% increase from October 2011 and a decrease of 8% from September 2012. However, the markets were closed for two days in October due to hurricane Sandy.i

In previous articles we discussed VIX futures as a mean-reverting market tending to find major price support between 10 and 15 and major price resistance around 40. However, within this range, market turning points do develop from time to time. The True Range indicator is a method of seeking changes in market momentum.

The True Range indicator and the Average True Range were developed by Welles Wilder, also known for developing the Relative Strength index, Directional Movement and the Parabolic Stop and Reverse. True Range is considered a metric of a market’s activity or volatility. Wilder first published the True Range indicator in his 1978 book “New Concepts in Technical Trading Systems”. The True Range indicator posits that the higher the number, the more likely the market will change direction. A lower number would indicate a weaker trend or indication of a sideways market. The True Range is defined as the maximum value of the following: 1) today’s high to today’s low; 2) yesterday’s close to today’s high; and 3) yesterday’s close to today’s low. The Average True Range is a moving average of the True Range.

VIX futures are an indicator of S&P 500 Index volatility and True Range is a volatility of the volatility or a second derivative of the READ MORE

Copyright ©2012 Mark Shore. Contact the author for permission for republication at info@shorecapmgmt.com Mark Shore has more than 20 years of experience in the futures markets and managed futures, publishes research, consults on alternative investments and conducts educational workshops. www.shorecapmgmt.com

Mark Shore is also an Adjunct Professor at DePaul University’s Kellstadt Graduate School of Business in Chicago where he teaches a managed futures / global macro course and an Adjunct at the New York Institute of Finance. Mark is a contributing writer to Reuters HedgeWorld.

Past performance is not necessarily indicative of future results. There is risk of loss when investing in futures and options. Always review a complete CTA disclosure document before investing in any Managed Futures program. Managed futures can be a volatile and risky investment; only use appropriate risk capital; this investment is not for everyone. The opinions expressed are solely those of the author and are only for educational purposes. Please talk to your financial advisor before making any investment decisions.

In the September 2012 newsletter, the article “VIX Trading Strategies” was the first in a series discussing various technical and quantitative trading strategies beginning with a simple moving average approach to trading the CBOE Volatility Index (VIX) VIX futures contract. This article discusses the use of the Aroon Oscillator.

The VIX futures contract tends to be mean-reverting, thus seeking overbought conditions is a logical approach to trading this market. As we noted in the previous article, VIX futures tends to trade between a major resistance near 40 and a major support of 10 to 15, and within that the market may trend.

Developing trading strategies involves the investigation of a market’s liquidity for various reasons, including the potential for slippage. On October 1, 2012, CBOE Futures Exchange, LLC (CFE) once again reported record volume in VIX futures. In September 2012 the Average Daily Volume reached a new record of 126,345 contracts versus the previous record of 102,587 contracts traded in June 2012. A new record was set in September 2012 of 2,400,552 contracts traded surpassing the previous record of 2,154,325 contracts traded in June 2012. i

For those not familiar with the Aroon Oscillator, it was developed by Tushar Chande in 1995. The oscillator first appeared in the September 1995 issue of Technical Analysis of Stocks and Commodities magazine. The word “Aroon” is Sanskrit for “dawn’s early light”, thus seeking changes in a market. The oscillator is the differential between the Aroon Up and the Aroon Down indicators which creates an oscillator indicating a market’s strength in a trading range.

It is defined as an oscillator because it ranges between READ MORE

Copyright ©2012 Mark Shore. Contact the author for permission for republication at info@shorecapmgmt.com Mark Shore has more than 20 years of experience in the futures markets and managed futures, publishes research, consults on alternative investments and conducts educational workshops. www.shorecapmgmt.com

Mark Shore is also an Adjunct Professor at DePaul University’s Kellstadt Graduate School of Business in Chicago where he teaches a managed futures / global macro course and an Adjunct at the New York Institute of Finance. Mark is a contributing writer to Reuters HedgeWorld.

Past performance is not necessarily indicative of future results.  There is risk of loss when investing in futures and options.  Always review a complete CTA disclosure document before investing in any Managed Futures program.  Managed futures can be a volatile and risky investment; only use appropriate risk capital; this investment is not for everyone.  The opinions expressed are solely those of the author and are only for educational purposes. Please talk to your financial advisor before making any investment decisions.

In the May 2012 newsletter article “Volatility Futures: Relative Strength: A Family of Futures Products”, we discussed various methods of trading volatility futures products as spreads or indicators, with some discussion of their basic characteristics.

This article will provide discussion of trading methods for individual volatility futures products. The CBOE Volatility Index® (VIX®) futures contract tends to be mean-reverting and trades within a range bound market.

Excluding the 2008 financial crisis, the VIX level tends to fluctuate between 40 and 10. For liquidity seeking traders, hedgers or managers, the chart below demonstrates the increasing volume and open interest in VIX futures, making it a viable choice for a liquid portfolio.

VIX futures trading volume recently reached a new high on three fronts:

1) In August 2012, the VIX futures average daily volume increased by 4.6% to 83,016 contracts versus August 2011 volume of 79,402 contracts.

2) The total volume year to date trading volume in VIX futures has increased by 59% to 13.7 million contracts versus January through August of 2011 volume of 8.6 million contracts.

3) On September 13, 2012 the VIX futures contract reached a new single-day volume record of 190,081 contracts traded. The previous record was 159,744 contracts traded on June 8, 2012.

In a range bound market, long term directional trading may not work as well as it would in other futures markets. Overbought and oversold indicators may have greater utility value. However in the shorter term (duration of days and weeks), directional trades may offer some value.

Read more

Copyright ©2012 Mark Shore. Contact the author for permission for republication at info@shorecapmgmt.com Mark Shore has more than 20 years of experience in the futures markets and managed futures, publishes research, consults on alternative investments and conducts educational workshops. www.shorecapmgmt.com

Mark Shore is also an Adjunct Professor at DePaul University’s Kellstadt Graduate School of Business in Chicago where he teaches a managed futures / global macro course and an Adjunct at the New York Institute of Finance. Mark is a contributing writer to CBOE’s Chicago Futures Exchange and to Reuters HedgeWorld.

Past performance is not necessarily indicative of future results.  There is risk of loss when investing in futures and options.  Always review a complete CTA disclosure document before investing in any Managed Futures program.  Managed futures can be a volatile and risky investment; only use appropriate risk capital; this investment is not for everyone.  The opinions expressed are solely those of the author and are only for educational purposes. Please talk to your financial advisor before making any investment decisions.

By Mark Shore
CBOE Futures Exchange “Futures In Volatility” Newsletter
May 31,  2012

Many investors are familiar with the CBOE Volatility Index (VIX) that is calculated based on options on the S&P 500 Index option and is an indicator of implied volatility and investor sentiment. But some may not be aware that CBOE Futures Exchange (CFE) lists and trades the VIX futures contract (Ticker symbol: VX).

The popularity of the VX futures contract has grown and the VX futures contract recently experienced its highest trading volume month in March 2012 with 1.96 million contracts traded, which is an 84% increase from a year earlier.

As the popularity of the VX futures contract increases, CFE continues to expand the volatility index franchise to include futures and security futures contracts covering several underlying markets. See the table below for a list of the volatility index futures and security futures that CFE currently offers for trading on its market.

From the retail investor to the institutional investor or money manager such as a Commodity Trading Advisor or hedge fund, there is always the question: “How can an investor utilize these contracts in a portfolio?”

Read more

Copyright ©2012 Mark Shore. Contact the author for permission for republication at info@shorecapmgmt.com Mark Shore has more than 20 years of experience in the futures markets and managed futures, publishes research, consults on alternative investments and conducts educational workshops. www.shorecapmgmt.com

Mark Shore is also an Adjunct Professor at DePaul University’s Kellstadt Graduate School of Business in Chicago where he teaches a managed futures / global macro course and an Adjunct at the New York Institute of Finance. Mark is a contributing writer to Reuters HedgeWorld and the CBOE Futures Exchange.

Past performance is not necessarily indicative of future results.  There is risk of loss when investing in futures and options.  Always review a complete CTA disclosure document before investing in any Managed Futures program.  Managed futures can be a volatile and risky investment; only use appropriate risk capital; this investment is not for everyone.  The opinions expressed are solely those of the author and are only for educational purposes. Please talk to your financial advisor before making any investment decisions.

EDHEC-Risk Institute has released hedge fund return figures from February. With the Standard & Poor’s 500 stock index up more than 3%, it should come as no surprise that dedicated short sellers got creamed, losing 3.22%. That pushed their year-to-date return to -4%. On the plus side, convertible arbitrage managers returned 1.66% in February, giving them a 3.5% return for the year.

See the full EDHEC results, with commentary, below:

EDHEC-Risk Alternative Indexes - Overview February 2011

Early word from The Hennessee Group is that hedge funds tracked by the firm’s index earned 1.9% in October. If that number holds up, it would follow a stellar September performance of 3.5% and put the Hennessee Hedge Fund Index up 6.6% for the year.

In a news release announcing the return data, Hennessee Group co-founder Charles Gradante said arbitrage, event-driven and credit strategies were the biggest drivers of performance last month. Those three strategies have outperformed long/short equity strategies all year, including in October, he said.

Still, hedge funds’ positive performance still appears to be tied closely to the performance of the broader markets. In other words, it looks beta-driven, and beta isn’t what investors pay 2 and 20 for.

The Standard & Poor’s 500 stock index earned 3.7% in October and is up 6.7% year-to-date, according to Hennessee. The Dow Jones Industrial Average was up 3.1% last month, putting it up 6.6% year-to-date. The Nasdaq Composite Index earned 5.9% in October and is up 10.5% year-to-date. Even the Barclays Aggregate Bond Index has been in on the act this year. Although it earned only 0.4% last month, it’s still up 8.3% year-to-date.

“The financial markets continued to rally as the companies reported solid earnings and the Fed announced an additional round of quantitative easing,” Mr. Gradante said. “Hedge funds posted strong positive performance, but lagged traditional benchmarks due to conservative exposure levels and losses from hedges.”

Cyclical trends don’t always revert back and forth as dependably as traders wish but a few glowing examples of wheels turnings can be found by looking at last year versus the year before, and at the last decade versus the one prior.

In the ‘00s, there was a single worst performing sector, and it was technology, according to Hedge Fund Research.

HFR’s Technology/Healthcare sector produced a ten-year return of 1.74% (average, annualized) which is not surprising considering that tech dominated the 1990s, a ten-year period in which the HFR tech sector index produced an average annualized return of 35.5%. If the current market rally indeed has legs and is the start of something lasting, there’s some likelihood that technology will lead the way. And if terrible performing sectors can prove a harbinger of good things to come look no further than the comeback of convertible arbitrage funds in 2009 versus 2008. Many styles snapped back in 2009 but few experienced the reversal of fortune as did convertible arb, according to HFR stats.

In 2008, that sub sector had returns of negative 34%, compared to negative 19% for the broad HFRI Fund Weighted Composite Index.

In 2009, convertible arbitrage sector notched a 59% return.

“At the end of 2008 there was so much capitulation in the market—investors just selling with no rhyme or reason, just needing to raise cash—it set the stage for pricing dislocation, the magnitude of which has never been seen before,” says HFR president Ken Heinz.

So what was the single worst-performing hedge fund sub strategy of 2009? That would be short-biased funds which as a group lost 23.47% last year.