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

After 2011’s volatile movements in the S&P 500 index, we received a long-term buy signal in mid October basis the June 2012 E-mini S&P 500 contract.

However, the market keeps bumping up against the 1365 to 1370 area and then sells off.

Currently on a long-term basis, the market would need to close below 1321 for a new short signal to occur. There is strong support in the 1337 area.

Our indicators are showing the market entering into an overbought region, but our long-term indicators can remain overbought or oversold for a while before the market finally begins to turn. However, we need to be aware of the area it has entered.

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Copyright ©2012 Mark Shore. Contact the author for permission for republication at info@shorecapmgmt.com www.shorecapmgmt.com Mark Shore publishes research, consults on alternative investments and conducts educational workshops. 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.

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 and futures trading 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.

If I won the lottery—I mean one of the big ones, like $200 million or more—I’d buy some land and buy or build a dozen or so of those 500,000-plus-gallon oil storage tanks. Then I’d start buying up crude oil futures and take the physical delivery. Sometime within my lifetime I’m pretty sure I would double, and possibly triple my money at today’s oil prices.

There have been two major stories playing out in the news of late: the oil spill in the Gulf of Mexico and troubles in finance. By “oil spill” I mean an economic and environmental catastrophe of epic proportions, one significant enough to affect oil production for years and possibly ruin not only the Gulf coast but also a good amount of at least the southern end of the Eastern seaboard. And by “troubles in finance,” I mean the exposure of shenanigans so egregious to the common man that it’s galvanizing political will on both sides of a sharply partisan Congress here in the United States and the disparate nations of the European Union to crack down through regulation.

I’m just not sure where we go from here. I don’t think it’s anywhere good. If we hope for an economic recovery, then as soon as one begins in earnest—one beyond adding Census jobs—we will see oil and other commodity prices rise. This dance will continue for a while, until the realization sets in that oil cannot be pumped out of the ground in sufficient quantities to sustain economic expansion at anything approaching the rates we’ve seen in the past. Once that happens, oil prices will rise permanently, and oil at $150 or more per barrel will be the new normal.

Without real economic expansion, what is there to trade, really, besides commodities? Just paper. And the way regulation is shaping up now, with strong business and finance lobbies still influencing the debate, imagine what might happen down the road, when the finance industry is weakened by world events and the results of the regulation we’re facing today. In five years, we are likely to have seen sovereign debt defaults on a scale previously unimaginable. That will weaken confidence in currencies and bonds as investments.

My oil play is really just a “money in my mattress” strategy, only I don’t even think I’ll want dollars, euros or yuan. I’m going to want to control something everyone else needs. And I’ll demand payment in gold. I’ll need something of value to pay the army that will be required to protect my oil, and me.

Strange and dark thoughts on this financial regulation- and oil-heavy news day. Maybe someone wants to weigh in from the glass-half-full side. Remind me that hedge fund returns were positive again in April, and that new housing starts are up. There’s good news out there somewhere, even for people who haven’t won the lottery. Right?

The Wall Street Journal runs a story today that purports to trace last Thursday’s wild afternoon market gyrations back to an options trade made at 2:15 p.m. ET in the Chicago pits by Nassim Nicholas Taleb’s Universa Investments LP hedge fund.

“On any other day, this $7.5 million trade for 50,000 options contracts might have briefly hurt stock prices, though not caused much of a ripple. But coming on a day when all varieties of financial markets were deeply unsettled, the trade may have played a key role in the stock-market collapse just 20 minutes later.”

In the story, written by Scott Patterson and Tom Lauricella with help from ex-HedgeWorld-er Jacob Bunge, the Journal cites unnamed traders who said the Universa trade—an out-of-the-money bet that the Standard & Poor’s 500 stock index would fall to 800 in June—caused counterparties to sell stock to hedge their exposure. The trade was conducted through Barclays Capital.

“The more the market fell, the more the traders at places like Barclays had to sell to protect their own positions,” Patterson and Lauricella wrote. “This, along with likely dozens of other trades across the market led to a cascade of selling in the futures markets.”

As volume rose, data feeds at brokerages and trading systems at the exchanges couldn’t keep up. Heavy trading begat more trading. At 2:37 p.m., according to the Journal, the Nasdaq said it would no longer route quotes to the NYSE’s Arca electronic trading system because of problems with the data it was receiving from Arca. BATS also stopped routing quotes to Arca.

“For a crucial set of players—high-frequency-trading hedge funds—all this turmoil was becoming too risky to handle…. With the high-frequency funds either selling or pulling out of the market, Wall Street brokerage firms pulling back and the NYSE stock exchange temporarily halting trades on some stocks, offers to buy stocks vanished from underneath the market.”

Reading the story, I understand what the Journal was trying to do: find the origins of a financial event that has everybody spooked. It is the natural way of news outlets to seek identifiable agents—people—to which an otherwise inexplicable series of events can be traced. But does anyone seriously believe a 50,000-contract out-of-the-money options bet on the S&P 500 initiated last Thursday’s market decline? That seems harder to believe to me than the “fat finger trade” error story.

In working the Taleb/Universa angle so hard in this story the Journal, in my view anyway, undermines its broader—correct—theory that electronic trading and exchange systems failed spectacularly. What happened on May 6 was definitely a computer problem, but attempting to tie it to a single trade by a single fund seems overly simplistic and kind of sensationalistic.

Let’s say, for the sake of argument, that Universa’s trade did spark the trading that crashed the electronic systems that exacerbated the sell-off. Where do we go from there? Do we restrict traders through regulation? Do we somehow apply “speed limits” to electronic trading networks and electronic exchanges during times of heavy volume? Neither really seems to get at what I think is the root cause: too much trading of stuff that by itself doesn’t have any real value.

At least one person in the comments section of the Journal story agrees. “David Ziegelheim” writes, “The problem really is nothing to do with electronic trading. The problem is that the trades do not represents anything to do with the value of the underlying companies. The trades are part of a gaming strategy against other investors as the market value far exceeds the underlying value of the company.

“This all comes from a lack of investment opportunities. That in turn is caused by tax and regulatory policies that make new investment unattractive. Investment shows up at the expense on the bottom line whether or not it is depreciated. Buying another company just moves one set of assets from one row to another. With huge amounts of money looking for a place to go and numerous money managers looking for ways to keep their jobs, this is just become a shell game that eventually will collapse. Maybe not last Thursday, but the day will come in the not so distant future where the “rule of sixes” will again be a valid investment strategy.”

All of this makes me think that much of what we see in the way of “market updates” on CNBC and elsewhere really fail to capture the true reasons behind what we’re seeing. Sometimes the reporting seems rooted in the old-fashioned notion that “investors’” views on securities are being represented in the prices. Investors like Home Depot, so the stock price is up. Investors don’t like Proctor and Gamble, so the stock price is down. Investors think the euro is overvalued or undervalued versus the dollar or the yen.

But maybe that’s not entirely, or even mostly, the case. It seems possible now that many of the intra-day price moves we see are not caused by human investor sentiment at all, but rather are a reflection of human-programmed but otherwise fully automated algorithms engaging in a complex dance across stocks, bonds, currencies and commodities.

I liken it to a computer conducting an orchestra versus a human conducting an orchestra. The computer can be programmed to actuate mechanical arms and hands that mirror the movements a human composer would make, and it’s even possible that a computer might be programmed to “listen” to the music and alter its composing style based on the audio feedback from the sound of the instruments. But the computer isn’t really feeling anything. And if it goes wiggy, things can go downhill fast.

It’s really the same any time you introduce computer technology into any sequence of events. Take the electronic engine control module on my motorcycle versus the carburetor on my wife’s bike. Most days I like the ECM. It gathers data from an oxygen sensor and automatically adjusts the air-fuel ratio to provide the optimal mixture for the given inputs of the moment based on preprogrammed criteria. In theory, if I tinker with the air flow in any way—either intake or outflow—the computer will adjust the fuel delivery based on the new information from the O2 sensor. On my wife’s bike, if I change the air flow, I have to take out my tools and tinker with the carburetor by hand to adjust the fuel delivery.

On the down side, though, if any part of the electronic engine control system fails, I’m dead in the water. A computer glitch can derail my ride. My wife’s carbureted bike has no computer that can fail.

This is my analogy-laden take, anyway. It’s also worth noting, as Journal story commenter “Adam Hendricks” did, that there’s not a lot of variety with computers. Many of these algorithmic systems aren’t all that dissimilar from one another, and many have similar goals. So when they all start moving fast, they’re also moving together. That’s bad from a correlation standpoint. Here’s Hendricks’ take: “Everyone is running virtually the same software, and the software did what it was supposed to do: follow trends, run predictive model algorithms, and send high speed buy and sell orders based on the model results on market behavior that is presumed to be caused by human behavior patterns. Such software was originally designed for small boutique investment groups to glean profits by mathematically modeling the behavior of the market as a whole. Such software doesn’t work well at all when every major trading house is using it. The model driven high speed trades feed off one another. The market is not being driving by human trading behavior anymore. It is being driving by similar software reacting in high speed to feedback loops on each other. That’s why it’s been such a roller coaster ride and will continue to be so.”

Hard for me to improve on that, but you all are welcome to do so in your own comments here.

I saw this was on CNBC earlier today, but the volume was down and I couldn’t listen. When I tried to watch online, either the CNBC feed or my computer was acting funky. I’ll leave it to you to listen to Darryl Jones of Florida A&M University and Daniel Mitchell of the Cato Institute debate the merits of taxing carried interest. Discuss.

Once again, two stories on the same topic make the case for making oneself a wise news consumer. Here are two stories about the same Credit Suisse hedge fund investor survey, one from Bloomberg and one from Global Pensions.

The Bloomberg story plays up the top point in the Credit Suisse news release: that global hedge fund assets under management should approach $2 trillion again by the end of 2010. That’s definitely the sexy angle, and the one most likely to appeal to a wider general business news audience.

Global Pensions opted to focus on institutional investors’ influence on redemption terms, specifically that 43% of investors surveyed have sought an increase in the frequency of redemptions and 39% have asked that lock-up provisions be removed from the terms. This is obviously of interest to pension funds, and clearly the reason Global Pensions chose to cover the survey in this way.

Interestingly, while the Global Pensions story briefly mentions the AUM figure, Bloomberg doesn’t even touch on the lock-up issue.

Knowing The Wall Street Journal’s penchant for throwing these stories behind the “subscriber only” gate after a while, let me give you the gist of this one: Dubai Opening Hedge Fund to Investors.

Dubai Shariah Asset Management launched a shariah-compliant fund of funds at the beginning of 2009. The fund returned 41% last year. It’s up about 1% through March 28 and is outperforming its peers.

Now DSAM plans to throw open the doors to its fund-of-funds kingdom, and a number of Islamic banks seem genuinely interested.

The DSAM Kauthar Commodity Fund has $260 million in assets and its stable of managers includes BlackRock Inc., Tocqueville Asset Management, Lucas Capital Management LLC and Zweig-DiMenna International Managers Inc. Each invests in commodity company stocks that have been screened to ensure they comply with shariah law, which forbids investing in perceived vices such as gambling or alcohol, and does not allow heavy debt burdens or traditional short selling.

All manner of business-friendly clerics have been called upon to certify that various hedge fund investment techniques are shariah-compliant by issuing fatwas. The message seems to be, shorting is illegal, except when it can make powerful people money, then it’s not. But I’m not a theologian.

My smart-ass point is: Dubai is getting into hedge funds. Excellent. Even better, they’re taking outside money. What could go wrong?

Call me an unintended acceleration skeptic. These days that’s like saying I don’t believe climate change is real or that I think the Earth is 5,000 years old.

I do believe climate change is real, however, and I believe all the science I’ve been taught over the years that the Earth has been around a lot longer than 5,000 years. But I don’t believe people’s cars are just running away out of control, not without some additional factors at play, anyway.

What’s the hedge fund connection? The smart money, in the short term, may be betting against Toyota’s share price. But in the long run I think the company will be a good long bet. (more…)

HedgeFund.net reports that the Securities and Exchange Commission, specifically the New York office, is going to ramp up its sweeps of investment advisers, in particular hedge funds.

George Cannellos tells the Tuna that the SEC is hiring more experienced agents, bringing in knowledgeable outsiders such as Norm Champ—formerly general counsel at Chilton Investment Co. and on the board of the Managed Funds Association—and generally approaching things from a risk-based perspective.

“In the last few months—really in the last year or two—we have tried to orient our program, especially the investment management program, more toward cause- and risk-based exams,” Cannellos tells HFN.

Wait, is it the last few months or the past year or two? And if you mean the latter, do you really want to stick with that? Has anyone mentioned the name “Madoff” to you? It’s been in the news…. (more…)

Update 12-24: TalkingBiz posted an update to this story on Wednesday: “Reuters editor in chief says story wasn’t spiked due to pressure.”

News organizations are supposed to break news, not make it. Too often, though, in my nearly 20 years in this business, the news has become the news. Jayson Blair, Patricia Smith, Stephen Glass, Rick Bragg, the reporting leading up to the Iraq War … the list goes on and on, and those are just the high-profile cases. Friends of mine—good, honest, hard-working journalists looking to tell the truth—have had stories killed for all sorts of reasons that had nothing to do with the accuracy or relevance of the pieces. (more…)