Tuesday, September 22, 2015

Circling Back on Backwardation

Our September 1st post, Looking at the VIX, focused on the fact that the VIX futures market moved into backwardation on August 20th and what that could mean for the market over the next couple of months.  As a refresher, backwardation occurs when near-term VIX futures become more expensive than longer-term VIX futures (in this case the 3 month VIX contracts).  It's a fairly uncommon event and suggests that traders are betting that volatility in the future (3 months out) will be lower than it is now.

We then looked at the times where backwardation had occurred since the 2009 bottoming process and found that the 2009-2011 period of instances looked quite different than when the event happened in the 2012-2015 timeframe.  Essentially, from 2012 to early this year, whenever this situation developed it was a pretty reliable indicator to buy the market as V-bottom recoveries became the familiar theme.  However, from 2009-2011, the S&P 500 was not as sure-footed in the days shortly after a period of backwardation and the index's results 5, 10 and 20 days out were a mixed bag.  You can see the charts for each period in the link above.

So we wanted to circle back on this thought and assess how things had unfolded since August 20th.  At the time, we suggested that this market felt a bit more like 2009-2011 than a market eager to put in a V-bottom ala 2012-2015.  So far, this has been the proper assumption with results having been decidedly negative and not at all indicative of a V-bottom.

Here's how the S&P has fared since backwardation happened on August 20th:

5-days: -2.361%

10-days: -4.155%

20-days: -3.814%

However, if we stick with the 2009-2011 analog, the numbers suggest that the market could see a handsome rebound over the next 30 trading days as the average 50-day return for this timeframe was 6%.

Ryan Worch is the Managing Director of Worch Capital LLC. Worch Capital LLC is the general partner of a long/short equity strategy that operates with a directional bias and while emphasizing capital preservation at all times.

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