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

As the introductory Commodity Corner column of the magazine I found this to be a good opportunity to introduce commodities and futures.

One could argue commodities have been around since the beginning of civilization. People have produced, paid or bartered for commodities to use for either production or to consume. Some of the uses of commodities include food, energy, construction, manufacturing, and clothing.

According to the Merriam-Webster dictionary, commodities are defined as: 1) an economic good. 2) A product of mining or agriculture. 3) An article of commerce especially when delivered for shipment. 4) A mass produced un-specialized product. [i]

In today’s global markets both large and small firms will trade and hedge commodities as part of their daily business as either a producer or end-user of the commodity. For example a chocolate candy producing firm will need to purchase cocoa, sugar and of course energy to fuel their factories. If they do business in foreign countries they may need to buy and sell foreign currencies for hedging or delivery purposes. (See “Currencies in Your Future Portfolio?” of the Spring/Summer 2012 issue).

To manage their price risk, a commodity producer, such as a farmer may sell a futures contract to lock-in their selling price. An end-user, such as a coffee chain may buy a futures contract to lock-in their purchasing price. Keep in mind commodity markets tend to be mean-reverting markets as they spike or decline from an average price and then revert back towards that average price overtime. This is often due to shocks in the system such as increased demand, reduction of supply, weather concerns, disruption of distribution channels or possibly political or regional events. If a commodity becomes too expensive, the market participants’ behavioral mechanism will appear as they seek less expensive substitutes. This is known in economics as the substitution effect and one of the differences to note between commodity and equity trading.

Commodities are traded in two common locations: either the spot/cash market usually reserved for industry or sometimes known as “commercials” such as producers, distributors and end-users as the actual physical commodity is traded. Or the products trade on an exchange such as one of the futures exchanges found around the world.  The futures exchanges are often utilized by both commercials and speculators. An exchange offers commercials the opportunity for immediate offset of their commodity risk by speculators offering liquidity to take on the risk. If a commercial has a loss from hedging, it often means they profited in the underlying cash market, because they are holding the opposite direction in the cash market. One can think of the loss on the hedge as a premium on an insurance policy.

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[i] Shore, M. (2011) DePaul University 798 Managed Futures Lecture notes

Copyright ©2013 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.

Mark Shore, Adjunct Professor of managed futures at DePaul University’s Kellstadt Graduate School of Business in Chicago and 25 year veteran of the futures industry notes increased interest in managed futures for the last several years.

“Assets under management in managed futures have increased nearly 63% since 2008, and over 700% since 2000 according to BarclayHedge.” To help explain the managed futures message, Shore announced DePaul University will once again offer a graduate level managed futures course in the spring.

As the demand for asset allocation education and alternative investment education increases, Shore notes, “individual & institutional investors and the graduate students are asking more questions about managed futures, a topic often found unfamiliar to many.”

Does the recent market volatility increase the interest to understand managed futures?  “The abnormal market volatility in recent years has a number of investors increasingly questioning the core principles behind a diversified investment portfolio, he said. “What’s needed is a greater understanding of dynamic correlation and tail risk.”

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Copyright ©2013 Mark Shore. Contact the author for permission for republication at info@shorecapmgmt.com Mark Shore has more than 25 years of experience in the futures markets and managed futures, 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 Mark is a contributing writer to Reuters HedgeWorld, the CBOE Futures Exchange and Micro-Cap Review.

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.

Although it hasn’t been written about nor formally discussed, understanding a managed futures investment from the standpoint of market environments and macro performance drivers first solves many problems for asset managers.

· It enables a quick description of the investment to provide the investor and understanding of how beta performance is generated

· Allows the asset manager to establish logical performance expectations in two sentences

· Sets up further structural analysis with performance measures relative to the strategy

· It enables logical strategic correlation consideration

· It explains how and why the investment operates

How Beta Performance Drivers Work

Each of the primary managed futures strategies have an environment in which they are expected to find success and relative failure.

For instance, several strategies are based on the market environment of price persistence.  These include trend following, breakout, momentum among the many similar named strategies.

Other strategies are based on the market environment of relative price divergence and then convergence back to a statistical mean.  These include relative value, arbitrage and strategies based on how pricing of one asset relates to a related asset.

Strategies based on the market environment of volatility utilize options and have a different set of considerations depending on the specific strategy type.

Describing The Investment

The first step in the analysis process is to identify this beta performance factor, which leads to an understanding of performance generation factors and can assist in setting expectations.  Using the market environment performance driver, an asset manager may describe the investment as such:

“This trend following program has a macro performance driver of price persistence.  It is expected to prosper when the price of a given asset moves in one consistent direction.”

In two sentences, the investor can set macro performance expectations when the investment should and should not work, as well as provide the core strategic logic as to why the investment is so uncorrelated to that of the stock market.

Performance Measures Relative to Strategy

Another reason to understand the performance driver concept is that the performance measures should be relative to each strategy.  For instance, trade time frame might be given a different weighting in a trend following program than certain volatility programs.  Expected margin to equity usage, win percentage and correlation to the equity markets during times of crisis are all examples of performance measures that are different relative to each strategy.

The important takeaway is with each performance driver, the relative alpha strategy considerations of the managers can vary.  Thus starting at the high level and working downward is most appropriate.

Mark Melin is author of three books, including High Performance Managed Futures, taught a course for Northwestern University’s executive education program and edits the web site www.Uncorrelated-Investements.com.  Entire contents Copyright (C) Mark Melin 2013

How does one define a previously un-definable topic such as High Frequency Trading (HFT)?

Sources close to the Commodity Futures Trading Commission (CFTC) indicate new thinking may be underway regarding the topic of High Frequency Trading (HFT). Speculation is this thinking could look at the relative market impact HFT may have in a given market move as a legal definition. Such a definition could consider the relative impact of a particular HFT player as a percentage of a market damaging move and could be used for potential CFTC action on the issue. This new thinking could be outlined sometime in March, sources said.

Current US regulation regarding HFT is considered by some market participants to be behind the curve relative to the European Union. In the EU, for instance, algorithm type is used as an identifier to determine market participant behavior during crisis conditions.

“There is significant uneasiness on the speed in markets,” noted Vassilis Vergotis, Executive Vice President, Head of Eurex, Americas.

For the full article, visit the source web site (requires free registration): http://www.uncorrelatedinvestments.com/blog/?p=59

Mark H. Melin is author of several books, including High Performance Managed Futures and taught on the topic at Northwestern University’s Executive Education program

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.

Richard Beales and Breakingviews columnists Antony Currie and Agnes Crane discuss criticism of Jon Corzine’s legacy after the collapse of MF Global and the likelihood that two overlapping U.S. regulators will ever merge.

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.

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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. 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.

Chief Compliance Officers (CCOs) at alternative asset management firms are facing increasing challenges overseeing and monitoring compliance with respect to investment guidelines and portfolio compliance mandates. To meet the new and growing challenges of effective compliance and risk management, a new trend is emerging among CCOs—namely, an expansion of the role to include greater involvement than ever with the investment process and, at the same time, expanded monitoring of portfolio compliance risk. Compliance risk can be broadly defined as monitoring compliance of investment style, portfolio construction and investment risk management, where these and other key areas relate to investment mandates, risk management guidelines and investor disclosures.

Several Factors Behind Heightened Oversight

CCOs are also introducing a wider regulatory focus on matters that reach beyond traditional “hot topics,” such as code of ethics and insider trading. These additional areas include investigating the control structure of the firm’s investment management practices and adhering to investor disclosures. Collectively, this heightened scrutiny stems from several contributing factors, including:

- Market events over the last several years have forced fund managers to meet investor demands for greater visibility into risk management policies and practices. As a result, there has been an increase in the level of investor disclosures surrounding portfolio strategy risk and compliance (e.g., control over “style drift” and concentration risk).

- Many larger, more experienced investors have been turning to separately managed accounts to gain access to prominent alternative investment managers. In doing so, these investors have been able to secure increased transparency and risk monitoring with respect to investment managers’ trading strategies, portfolio construction, risk metrics and portfolio performance.

- Additionally, with the implementation of Dodd-Frank, there has been a significant increase in the sheer number of SEC-registered advisors. This brings with it the attendant burdens of demonstrating and documenting appropriate compliance with investment policies, procedures, and other elements that comprise fund offering memorandums, external marketing materials and internal operating manuals.

To meet these and other new dimensions of external scrutiny, CCOs are more acutely focused on thoroughly understanding their firm’s investment and risk management environment in order to measure, monitor and report on portfolio risk against established investment policies and limits. While the extent and involvement of the CCO will vary by firm, “best in class” CCOs will focus on closer interaction and collaboration with risk managers in learning both the qualitative and quantitative dimensions of investment styles and strategies, portfolio construction processes, risk management framework, pre- and post-trade limit monitoring, periodic portfolio compliance reviews and testing.

Larger alternative asset management firms have responded to these demands by formalizing the risk management function through the addition of an independent Chief Risk Officer (CRO) to assist the Chief Investment Officer (CIO) and portfolio managers in making sound investment decisions. CROs are also playing the role of policing investment guidelines and risk management rules. To support the CRO and the risk management function, firms are making significant investments in building a comprehensive and integrated risk management framework. This may include establishing the proper governance to define appropriate measurements based upon investment guidelines and investor disclosures, defining policies and procedures to properly monitor compliance with such measurements, implementing advanced risk technology to measure risk limits and portfolio performance, and conducting stress testing and scenario analyses. Even with the sufficient levels of risk management experience and resources available at larger firms, implementing risk frameworks remains a challenging and time-consuming task and an even bigger challenge for smaller firms.

New Hedge Fund Launches Spur Scrutiny

As reported recently, new hedge fund launches during the first quarter of 2012 reached the highest level since the fourth quarter of 2007. At the same time, we are seeing a significantly sharpened focus on newly registered alternative asset managers by regulators. The SEC’s short term strategy includes examinations of a significantly large number of newly registered managers and reviews of marketing materials as well as all compliance policies and procedures, among other materials.

Although start-up funds typically lack the budget and resources of larger, more established firms, they still bear the same “burden of proof” in terms of fulfilling their fiduciary responsibilities and contractual obligations. For this reason, newly launched alternative managers are facing major challenges in the area of compliance risk monitoring. Whether they bite the bullet and invest in advanced risk technology and staff resources or leverage third-party service providers with the necessary scale and risk-management experience, newly launched alternative asset managers must ultimately check the same compliance and risk boxes as their largest, more seasoned rivals.

To be precise, firms are not looking to outsource the risk management function, which is the mandate and responsibility of the portfolio management team. What they seek are experienced risk professionals along with the risk technology needed to help them meet the demands of investors and regulatory requirements. This can range from establishing a sound risk governance framework and designing customized risk reporting to advising on customized stress testing and scenarios analyses, and more.

While they face fierce competition for investor allocations and must closely manage costs, firms increasingly view operational, compliance and risk infrastructure as a competitive advantage. Sustaining that competitive advantage while continually adapting to a dynamic regulatory environment has led to ever-widening demands for complex, cross-functional capabilities, intelligence, analytics and intensified reporting horsepower. It is in the midst of this historic transformation that firms need to be thinking pro-actively about the solutions they are implementing in the course of managing formalized risk management and compliance practices within a continually evolving alternative asset management industry.

Shyam Prakash is Director of Risk and Steven Richard is Managing Director of Risk at Gravitas Risk Analytics & Advisory Services, a provider of co-sourcing solutions for technology, investment operations, risk and research support to the alternative investment and financial services industry. Gravitas is based in New York with offices in Chicago, Greenwich, Mumbai and Ahmedabad, India. (www.gravitas.co).