The VIX According to a 20-Year-Old 'Seinfeld' Episode
The foreshadowing from Cosmo Kramer and George Costanza is uncanny.
In addition the VIX isn’t weighted for volume, only price and strike. Therefore, taking Friday’s trading as an example, despite seeing the most activity, the 1300 strike with 14,392 contracts at 24% IV provides very little contribution to the index. Without doing the actual math it’s quite possible the difference would be negligible, but it still would seem that a volume or dollar weight would more accurately reflect what IV premium investors are really buying.
The other aspect of the VIX that doesn’t reflect the current extreme sentiment is that the spot index doesn’t show the massive skew in the futures curve. For instance, on Friday the difference between the front and back months is over 10 points with the 2013 futures in the mid to high 20s. Contrast that with this same time in 2007 when arguably the systemic risk was extremely elevated; the VIX futures curve was inverted with futures trading at a discount to spot.
Earlier this week I commented via Twitter that when I watch the way the tape trades I see a stupid little kid that hasn't learned his lesson. Friday’s opening gap lower and reversal to close at the highs was just another example. It seems everyone wants to short this market but it won’t go down. I’m not suggesting either Costanza or Kramer is correct at these levels, but rather that the market is still in the process of flushing Seinfeld’s weak hands.
Going into August it seems the market has not been able to shake its post crisis crash paranoia. As posited a couple weeks ago in Bernanke’s Astonishingly Good Idea, the market appeared to be thinking it was August 2011. It’s like Kramer has continued with his melodramatic prophecies of gloom and doom and Seinfeld can’t take the thought of losing any more money.
It’s evident when you look at the positioning. According to ICI, for the week ended August 1 equity funds lost $6.9mm while fixed income funds gained $5.0mm. This is a continuation of the trend since 2009 where equity funds have seen $210b of net outflows while fixed income funds have seen $925b of net inflows.
It’s not just retail positioning. Large speculators have been short the S&P e-mini contract for the entire rally off last year’s low and just this past week finally covered to get flat. Last week the Stone McCarthy Portfolio Manager survey for week ended August 7 showed fixed income managers to have their highest Treasury allocations since September 2007 while having their lowest allocation to spread (risk) product since November 2007. This is truly remarkable considering where Treasury yields are and is further proof that fixed income PMs were also positioned for August 2011.
But after two weeks into August risk assets haven’t crashed and now the market is at the post crisis highs, looking like it wants to break out despite decelerating economic and earnings growth. Investors are hearing it from both Costanza and Kramer and the uncertainty with whether they will get suckered yet again gets more intense the longer the market rally lasts. It is a dangerous time for all investors, retail and professional alike, but if this market remains bid into the Labor Day weekend, there will be tremendous pressure to get exposed to risk into year end.
The foreshadowing from that episode over 20 years ago is uncanny. The 2008 financial crisis wasn’t about blowing up the credit bubble per se; it was about flushing the market hubris that had resulted from it. The conspiracy theory that the game is rigged and “you can’t win” is exactly what you would expect after consecutive bubble crashes, and it’s evident in how investors have approached their post crisis confirmation bias. That’s because while the price changes, the technology changes, and the media changes, sentiment doesn’t change.
You know what I mean? Cause you send your money out there -- working for you -- a lot of times, it gets fired. You go back there, "What happened? I had my money. It was here, it was working for me." "Yeah, I remember your money. Showing up late. Taking time off. We had to let him go."