So you want to be a CBOE Volatility Index (VIX) rock 'n' roll star? Just don't leave a position open heading into expiration. Your odds are probably better playing daily fantasy sports head-to-head vs. IBM's Watson.

Just to refresh, VIX futures and options cash settle on the morning of their expiration day. Regular November VIX options expired on the opening rotation Wednesday. The important point is that it's a calculated VIX (symbol VRO). It's based on the opening print or quote in all qualified S&P 500 Index (SPX) options series. Since not all series open at the same time, the actual VIX prints you see on the board near an expiration day open may not be identical to the VIX settlement price. But they usually bear some sort of relationship.

But not always. As in, yesterday. Here's how VIX itself looked near the open:

That big red stick is the opening minute. VIX figured to open down as the market was modestly strong. But that far down? Odd. The large range is kind of strange, too, considering the market open was relatively quiet. But hey, it's VIX expiration, so we do expect some quirks. And someone clearly wanted to jig the VIX settlement price down, right?

Well, maybe not so much. The VIX range of the first minute was 18-18.93. In fact, that was the range of the first 40 minutes, too. Yet the VIX settlement price was 19.16.

Wait, what? How is that possible?

Again, VIX "settles" on a calculation, based on the implied volatility of all qualified SPX series. A series qualifies if it has a transaction, provided at least one of the two series closer to the money have a transaction. In other words, the December 1,900 puts will make it in if either the December 1,905 puts or December 1,910 puts trade. Once two series in a row don't trade, then nothing else further from the money is in the calculation.

As "luck" would have it, every SPX December put on the board qualified for the calculation. I mean literally every series; there was a trade in December 100 puts. Some strikes saw no volume, but not two consecutive strikes, so literally every quote made it in.

I'm not entirely sure how this transpires, though I'm guessing interested parties cross a whole phalanx of worthless put spreads at zero. Whatever the case, it happens and it settles VIX at an artificial price -- and someone clearly makes out quite well on the cash-out. It always happens, though it's not usually this absurdly disconnected from actual VIX. Your only defense is to not let any position sit open into the runoff and exposed to a price move that, dollars to donuts, will not work in your favor.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

I had one further thought on the CBOE Volatility Index (VIX) Expiration Games of Wednesday. Having the whole VIX put board trade serves to bump VIX marginally higher throughout the entire trading day, not just the open. Obviously, the ostensible purpose is to impact the cashout price. But the effect remains all day.

All the way out-of-the-money (OOTM) put series carry an extremely high implied volatility. They are all worth 0, but if they're quoted at 0 bid, 5-cent offer, they go into the calculation as "worth" 2.5 cents. That's an enormous implied volatility.

On the other hand, they are all way away from the money, so they don't carry much weight in the calculation. But add them all up, and it's "not nothing." It's going to bump spot VIX up on expiration day, ever so slightly.

And then the next day (Thursday), when VIX goes back to normal, it will lose that modest bump. It will manifest as underperformance … and probably set off alarms somewhere in the tinfoil reaches of Twitter. It's tough to quantify, in that there's lots of moving parts in any given day and the effect is probably on the small side.

It's important to note that VIX itself artificially printing a little high and then subsequently reverting does not have any monetary implications. Remember, the VIX itself is just a calculation. It proxies implied volatility. It's important to differentiate that from the tradeable VIX universe, where these S&P 500 Index (SPX) put order games do in fact have monetary implications. And as we noted yesterday, that's not VIX, that's VRO.

It also highlights a point we mention from time to time: VIX is never perfect to the penny. There are expiration quirks like these; there are quirks around news flow as well. Options often get bid up into known events like Fed meetings, and then often sell back down after the news is out. And there are calendar quirks -- as in, no one loves owning options and paying time decay into weekends and holidays.

And that reminds me … we're about to hit Thanksgiving week! If the most exciting news is anticipating one-hour's worth of Black Friday anecdotal shopping tales, then there's nothing much going on that's going to impact implied volatility. In fact, that's almost always the case; it's a very slow news week punctuated by what's basically a four-day weekend. It's highly likely VIX will dip over the next few sessions, and it's not likely predictive of anything related to volatility coming out of the break.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research

It's hard to believe that one week ago I was writing about an overbought CBOE Volatility Index (VIX). Five trading days and 3.5% in the market later... not so much, any more. It took all of three trading days for VIX to go from 25% above the 10-day simple moving average to under again, which means I can update my chart (yay!).

For the second "instance" in a row, the SPDR S&P 500 ETF Trust (SPY) bottomed on the first day VIX closed overbought, and then rallied strongly. Which I'm sure means it won't work so well the next go around.

Everything seems to suggest we're still in bull mode, and these are just pullbacks. Well, everything except the fact that the market still stops in this range, same as it kept doing pre-August.

Longer-term though, I do believe VIX is transitioning from the "low" regime that began in 2009-10. The median VIX in 2014 was 13.67, while this year so far it's 15.11. That's not a lot, but it's a very modest nudge higher. I'll guess it nudges higher still next year.

I'm not so sure that means the market will go lower, though. We did see this pattern in the mid-90s, and volatility -- and the market -- kept lifting for a few more years before the actual bubble.

Generally speaking, it's like the August dip never happened. The S&P 500 Index (SPX) "troops" are in almost perfect equilibrium. Literally half the SPX names sit above their 200-day moving averages now -- quite the recovery from the August lows near 20%.

Chart courtesy of StockCharts.com

CNN's Fear and Greed Index is now net Indifference and Indifference. The volatility component is... you guessed it... neutral. What's more, so is the put/call component.

Image courtesy of CNNMoney

It's tough to make the case for much of anything here. This week figures to be a snooze-a-rama with the holiday -- and then we have the Fed, though I'd note it feels like 98% of the inevitable rate hike is priced in now. That won't stop the Financial TV Obsess-a-thon, but it's not likely to cause a major market move at this point.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

CBOE Volatility Index (VIX) expiration morning is an interesting time for options trading -- that is, if you find an inordinate quantity of out-of-the-money (OOTM) put orders "interesting." Here's the deal. Lots of OOTM puts in the S&P 500 Index (SPX) trade on every VIX expiration. VIX futures and options cash settle based on the opening quotes on the SPX board the day of VIX expiration. Here's a rundown of the series that went into the VIX November expiration: 132,916 December puts traded from the 1,750 strike down to the 975 strike.

I erroneously thought that all strikes qualified for the settlement, but it "only" went down to 975. I eyeballed the board and didn't notice two consecutive strikes not trading down there. My bad.  

Anyway, is that a bit high for an open? Well, I'm looking at the board mid-session on Monday and maybe 3,000 have traded -- and over half in one series (December 1,475s). So, clearly, something happens on VIX expiration. It's not rocket science to connect a volume surge in mostly far OOTM series to the fact the prices of these series matter, insofar as the value of the VIX contracts are concerned.

The CBOE is well aware of this and does take many steps to regulate and shine light on the process. It's described here.

All "strategy" orders (more on that in a sec) must be submitted to what they call their Hybrid Operating System, or HOSS (not to be confused with Giants Super Bowl XXV hero Jeff Hostetler, also called "Hoss"). Orders must be in by 8:15 a.m. CT and then can't be modified from that point on until after the open. HOSS disseminates public info about imbalances here.  

Thus, all the info is publicly available. If you have an expiring VIX position, you can know or infer what's likely to happen to it on the SPX open. What you can't do is modify that position, as the expiring VIX products do not trade on the Wednesday open -- they just cash out.  

What's a "strategy" order you ask? The CBOE defines it as follows:

"In general, CBOE shall consider option orders to be related to positions in, or a trading strategy involving, volatility index options or futures for purposes of CBOE Rules 6.2B.01 and 6.2B.08 if the orders possess the following three characteristics:

"1) The orders are for option series with the expiration that will be used to calculate the exercise settlement or final settlement value of the applicable volatility index contract. For example, in the case of VIX futures, the orders would be in standard SPX option series that expire one month following the expiration date of the expiring VIX futures contract.

"2) The orders are for option series spanning the full range of strike prices in the appropriate expiration for option series that will be used to calculate the exercise or final settlement value of the applicable volatility contract, but not necessarily every available strike price.

"3) The orders are for put options with strike prices less than the 'at-the-money' strike price and for call options with strike prices greater than the 'at-the-money' strike price. The orders may also be for put and call options with 'at-the-money' strike prices.  

"Whether option orders are related to positions in, or a trading strategy involving, volatility index options or futures for purposes of CBOE Rules 6.2B.01 and 6.2B.08 depends upon the specific facts and circumstances. Other types of orders may also be deemed by CBOE to fall within this category of orders if CBOE determines that to be the case based upon the applicable facts and circumstances."

Long story short (probably too late for that already), traders essentially create "strips" that replicate the VIX settlement. I presume it's offset by the cash out in the actual VIX paper. The whole process is very transparent.

The vast majority of players not on this side of the trade only have exposure to this whole process if they have expiring VIX positions -- it does not affect non-expiring VIX positions. If you choose to leave a near-the-money VIX option open into VIX expiration, you run the risk of an unfavorable run-off. You also might benefit from the run-off. Just know that's what you're gaming and decide whether that's a game you want to play.

Take last expiration for example. November 19 calls seemed likely to expire worthless. VIX itself closed and then opened below 19. Yet VIX settled above 19 on the SPX put fiesta. If you owned the calls, great, you cashed out at 17 cents per contract. If you were short the calls, that's 17 cents given away.

There's nothing particularly nefarious about the whole shebang. It's just worth learning about if you ever intend to leave positions on.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

Welcome back! Hope everybody enjoyed their turkey/football/shopping over the weekend.

There’s no vacation for the CBOE Volatility Index (VIX)! Well, maybe a little vacation. They still calculate VIX so long as the market remains open; it just doesn’t tend to do much.

Thanksgiving week was no exception to the general holiday malaise. I generally expect VIX to underperform vs. expectations a bit, thanks to the effect of time decay on options prices in quiet times. But that wasn’t really the case, though more because essentially nothing happened net-net.

The SPDR S&P 500 ETF Trust (SPY) rallied a whopping 0.25 on the week. VIX dropped an even whopping-er 0.35 ... so, I guess it did actually underperform by a tiny amount. It "should" have only dropped by 0.04 or so. We'll call that extra 0.31 the holiday effect. But it's really a rounding error and best ignored. VIX will likely make back its "underperformance" by the first tick today.

Oddly enough, VIX is actually trending towards more responsive to every SPY tick. Here’s a look at the lagging "best fit" 20-day ratio of VIX moves to SPY moves.

​

Remember, it's a negative relationship; thus, as less continues to happen market-wise, VIX is getting more and more responsive to every little SPY tick In other words, it's grasping for something to do. And historically, this ratio is on the high side all year. Over the course of SPY history, the ratio is about -3.86, though in recent years it's averaged about -6.

If you want to read this bearishly, you can point to this spring. VIX started moving more strongly vs. SPY for a couple months while the market itself flatlined ahead of its August mini-melt. But more likely, it's not terribly predictive. Since Day 1 in SPY, the ratio has only a 0.014 correlation to SPY returns one month ahead. So while it's interesting to see VIX respond more to the market, it's ultimately not telling us much.

How about VIX futures? There's no particular holiday effect there. It's possible traders see something out in time while everything else is in Snoozeville.

​
Chart courtesy of VIX Central

In this case, not so much. There was literally no change in the term structure last week. The Slope Remains the Same, and that hedge against the permanent VIX lift six months out that rarely happens remains in the On position.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

You've probably read/heard more than enough about Black Friday and Small Business Saturday and Cyber Monday. But let's say, hypothetically, you're still looking for some gift ideas.

May I suggest not using volatility exchange-traded funds (ETF) as a stocking stuffer this year? I mean, I know the kids love them, seeing as how they can scare their siblings and all with Mattel's new "Volatility Asset Super Hero" toys. But unless you want to only have them get gifts as a "trade," I'd stay away.

I did a little browsing in the derivative aisle and I don't like what I see. It's a relatively uninteresting year for the CBOE Volatility Index (VIX) so far, net-net. It had a rush near year's end in 2014, so comps always figured to be tough. It's down about 16% year-to-date, but with the S&P 500 Index (SPX) up 1% or so, it's not terribly out of line.

The iPath S&P 500 VIX Short-Term Futures ETN (VXX)​, however, not so much. See the chart below:

Well, it hung pretty even with VIX through the end of April, but it's severely lagged since then. On a day-over-day basis, it typically moves about 40-45% of the VIX move. That's very variable, though. But, over the course of time, the contango effect hits and the lag gets worse.

There's no question a VIX churn hits VXX the hardest, but frankly, the real underperformance is thanks to the fact that VIX futures (and, ergo, VIX) never really caught up to the big VIX pop in August. Mean reversion assumptions are tough to shake. We did see the futures pretty much all north of 20 at the peak, but it was all relatively quick, and now we're basically back to where we almost always sit.

In the spirit of holiday sales, you do get VXX at a discount, right? Well, not really -- there's no value. It's a math calculation. If anyone ever tells you VXX is "cheap," run away, fast. At least there's one thing VIX owners can be thankful for. That is, they did better than double VXX!

Only down 78.4% this year, wahoo! The VelocityShares Daily 2X VIX Short-Term ETN (TVIX), of course, combines the best of the contango weight of VXX with the compounding effect of a tracker and double leverage. Just hope your kids don't google this one!

If you want the anti-VXX, sort of the Darth Vader of volatility lovers, there's always the VelocityShares Daily Inverse VIX Short-Term ETN (XIV):

That's actually the worst chart of all, and all it did was ultimately make the same net move as VIX. XIV is inverse VXX. It always underperforms simply shorting VXX, but usually not quite this badly. Compounding kills, and I guess the churn this year was net-net pretty awful.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

There's a Chicago Board Options Exchange (CBOE) volatility shindig going on now in Hong Kong. It's a little bit outside my paper route, so I'm not attending. But we do have several updates via the CBOE options hub website.

Buzz Gregory of Goldman Sachs had some interesting things to say on the current state of the volatility market, which we can go over in bullet point form:

"It was noted that both SPX and VIX option volumes continue to steadily grow with volume experiencing dramatic increases occurring around market events."

I'd note it also spikes wildly around CBOE Volatility Index (VIX) expirations, but that's a topic for another day. Is the relative spike around news (say, an anticipated Fed meeting) greater nowadays than in the past? That I'm not sure about. It's a tough data set to analyze, as not all news events are of equal magnitude. Though I suspect we do obsess more over certain anticipated news, and it's logical that would translate into greater options volume spikes.

"About 36% of SPX option volume occurs in contracts with 10 or fewer days to expiration and just over 50% of VIX option volume occurs in the front month contracts."

It's pretty amazing to see how weeklies have transformed the way we trade options. Regular monthlies expire either every 28 or 35 days, so basically two-thirds of the time there were no options that close to expiration to even trade. As for VIX, frankly, I never understand a play beyond the front month -- at least, I never understand a play that goes long VIX out in time. If you anticipate a vol spike, play for it in the here and now, in my humble opinion.

"VIX tends to trade at a premium to realized volatility with the average spread being about 4 volatility points."

I use that 4-point premium as a guideline. Glad I'm not alone ... though I was pretty sure I didn't just make it up.

"He spent some time equating VIX to the economy and noted that VIX is higher during recessions stating that the average for VIX during recessions is around 26 while it is 17 during periods not experiencing a recession."

VIX does trade in regimes of about four-to-six years. We're likely in the early stages of transitioning from a low regime to a high regime. I never really thought about how it corresponds to recessions and expansions, but I guess it makes some sense. We saw high VIX in the late '90s into 2003, and again from 2007 to 2010-ish, so there was some overlap with recessions. I'm not sure the investing of this, though, as VIX is more reflective of the recession than predictive.

"When discussing structuring a VIX trade he noted four factors to consider -- S&P 500 returns, term structure premium, volatility risk premium, and mean reversion of VIX versus its long term average."

Very true. To me, the volatility risk premium is perpetually too high. If you have the capital and the willingness to act as a de facto insurance company, it's going to pay overtime to fade those overpaying for "tails."

"With respect to using SPX or VIX options to hedge a portfolio Buzz noted that it is not necessarily an either/or decision."

I tend to believe straight puts offer a better deal than VIX paper. But specifics do matter. And there's no reason you can't mix and match the two. The iPath S&P 500 VIX Short-Term Futures ETN (VXX), for example, behaves very much like a standard index put option. They both decay over time, just for different reasons.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

In our never-ending quest to bring you ways to analyze the CBOE Volatility Index (VIX), I bring you … the CBOE 3-Month Volatility Index (VXV)! It's VIX, only longer. While VIX proxies the implied volatility of a 30-day S&P 500 Index (SPX) option, VXV proxies implied vol on a 90-day option. As such, it moves less, as the longer you go out in time, the more mean reversion assumptions set in.

It moves almost in lockstep with VIX, only at a lesser magnitude. Here are the two pups together in 2015, for instance:

Not much there to the naked eye. But alas, the ratio between the two varies a bit. VIX averages about 0.93 of VXV. It does have its variation, though -- especially when VIX pops. VXV is much slower to assume the volatility pop will persist, identical to the way the VIX futures term structure acts.

My question is: Can we find much in the way of predictive value as to future market returns? On the surface, there's not much. The correlation between VIX/VXV ratio and one-month-forward SPDR S&P 500 ETF Trust (SPY) returns is an uninspiring 0.0324. The scatter plot is one big blob.

But alas, there's some signal in the extremes. The data only goes back to mid-2006, but that encompasses pretty much every sort of market backdrop. The VIX/VXV ratio closed at 1.10 or greater 113 times, or about 5% of all days. The average one-month forward return on those days is 0.22%; pretty lousy compared to a randomly timed one-month return of 0.75%, back to mid-2006. But the median tells a different story. The median return of owning SPY for one month forward when the ratio hits is 2.69% vs. a median of 1.49% for randomly timed one-month holds.

What we have here is a case of the data overlaps intersecting with 2008. What if instead, we do like we do with VIX vs. its simple moving average (SMA). That is, separate it into "incidents," so we're not reusing the same data. Here's the system: We buy SPY if the VIX/VXV ratio is 1.10 and hold for one month.

It looks pretty good. There are 25 "signals" over nine plus years, and the average return is 1.94%, median is 2.90%. The trade won 17 times. There was one huge draw-down of 16.37% in 2008.

It's a similar principle to the VIX 20% over the 10-day SMA, with moderately better results. And it reinforces the notion that fading an overbought VIX tends to work.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

I talk about CBOE Volatility Index (VIX) mean reversion all the time, but there's an even greater mean reversion force going on these days: SPDR S&P 500 ETF (SPY) mean reversion.

With one month to go, the best description we can give 2015 is "One Big Churn." If you don't like the prices one day, have no fear; you'll see a price you like better soon. As SPY failed yet another pop above 210, I took a look at how often we've visited some SPY "fulls" this year. I define that by if the "full" (say 207) was in that day's SPY range. If SPY has a range of 207.10-207.90, that day "saw" just a 207 full; if the range was 207.10 - 209.90, it saw 207, 208 and 209 fulls, et al.

We've had 233 trading days this year. Here's how many days touched fulls from 206-210. "None of the Above" means it never touched any of them (that is, either the high was less than 206 or the low was greater than 210.99.

None of the Above wins. Barely.

Another way to look at it is that the range I considered is about 2.4% of SPY. And on 63.5% of all days, we've at least flashed somewhere within that range. Most days, it was more than just a drive-by. On 73 days (31.3%), it spent the entirety of the day between 206-210.99.

Yada yada yada, we're going absolutely nowhere slowly. This won't, of course, last forever. Maybe this week's market ugliness will gather steam, just like in August.

The problem is, you'll go broke trying to time the end of a trend, so it sets forth some clear strategies. Selling straddles or strangles and hedging conservatively has worked well all year. That has open-ended risk, though, so it's possible one bad hit in the August swoon wiped out several cycles of wins.

That makes iron condors a more desirable strategy, IMHO. It involves selling out-of-the-money (OOTM) call spreads vs. OOTM put spreads. Better yet, sell the call spread into the top end of the range and put spreads at the lower end. It's not always that easy (OK, it's never easy). But in principle, it's worked well this year. And yes, this trend of no-trend will end, but the main advantage of the condor is that the risk is defined as you're always stopped out at the highest and lowest strike. Even if you leg and never sell the opposite side, your spread is stopped out.

Simply just fading moves via futures and index ETFs works well, too. Everyone on Twitter catches every bottom and top, so it must work well. (That's another way of saying it's a good plan in theory -- just be disciplined with risk exposure and stops). Overall churn is awful for VIX ETFs, as we noted the other day. Shorting them works as a way to play for more churn, but the risk is very high, so I wouldn't game it that way.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research

Consider the trader that shut his machine down a week ago Friday and spent the week in a cave. SPDR S&P 500 ETF (SPY) was 209.56, CBOE Volatility Index (VIX) was 15.12. 

And then Our Trader returned from the Cave a week later and found… SPY at 209.62, VIX at 14.81. Presumably, very little happened. 

But alas, not so much. There was a pretty good trade in there if you timed it well. SPY closed at 210.68 on Tuesday, dropped to a close of 205.61 on Thursday after dipping as low as 204.75, and then popped to 209.62 on Friday for a round-trip to nowhere. 

As always, we churned a lot and got nowhere. Again, two strategies continue to work: 

1. Sell volatility and go spend the week in a cave
2. Fade every move

We're nearer the high end, so it must be time to play off the short side and/or sell call spreads. Obviously it's not that simple; this won’t last forever. But until it stops, why fight the overall trendlessness?

VIX futures didn't do all that much this week net-net, either:

 

It's a very slight drop across the board. Good to see that assumptions of a lasting VIX rally six months out remain intact.

Perhaps the ugliest spot on a relative basis was our good friend iPath S&P 500 VIX Short-Term Futures ETN (VXX). It dropped from 18.80 to 18.22, which is a lot for a nothing week. Again, Churn is Public Enemy No. 1 for VXX. Market churn begetting VIX churn is the worst possible domino effect. VXX remains the worst way to play for/hedge against a market drop.

We have the Most Publicized Rate Hike Ever coming up soon. I'm pretty sure it's discounted by now, but who knows how we react when it does actually happen? My guess is that the market will do the opposite of whatever it does right into the move and somehow we'll be right around here all over again.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research

It's natural that downside protection costs more than a hedge against an identical upside move. Part of that is thanks to human nature. We're simply wired to hate losses more than we "enjoy" gains. Greed is "good," but risk aversion rules the roost.

The major reason, though, is that the world is simply net long. There's just naturally more demand to hedge downside than upside.

So the fact that we see the world at large pay "up" for puts, and for derivatives like CBOE Volatility Index (VIX) futures, makes perfect sense. There are many ways to gauge "skew," but all suggest it's just a question of the degree that investors pay up.

What's noteworthy now is the degree to which the investing world pays up. By all accounts, it's as high as ever, especially in the context of the actual risk. Bloomberg has a very interesting theory here about what's going on:

"For more than a year, dealers in the U.S. equity derivatives market have noted a widening gap in the price of certain options. If you want to buy a put to protect against losses in the Standard & Poor's 500 Index, often you'll pay twice as much as you would for a bullish call betting on gains.

"New research suggests the divergence is a consequence of financial institutions hoarding insurance against declines in stocks.

"... While various explanations exist including simply nervousness following a six-year bull market, Deutsche Bank AG says in a Dec. 6 research report that the likeliest explanation may be that demand is being created for downside protection among banks that are subject to stress test evaluations by federal regulators. In short, financial institutions are either hoarding puts or leaving places for them in their models should markets turn turbulent."

In other words, blame the post-2008 stress tests! I can't prove or disprove any of this theory, but it does make some sense.

But here's the flip side. It suggests there's some serious asset mispricing going on. There's a subsector of the financial world that essentially takes the other side of this trade. In 2015, it's mainly hedge funds, but it's essentially available to anyone willing to become a de facto insurance company and take on more risk.

"Tails" are overpriced. Over time, selling puts, selling VIX futures, etc. should work under those conditions. Way smarter minds than yours truly know this quite well, and surely put on variations of this all the time. The greater the overpricing, the more demand there will be to try to fade the "tails."

That's a long-winded way of saying it's an interesting theory, but there has to be an equilibrium somewhere, at some price. The increased natural demand for protection from banks certainly increases that price, but it can only explain so much about what's going on.

Are risks higher than we commonly think? Or, better, is perceived risk higher than we think? Tough to know, but it sure seems like at the end of the day, there really is a higher fear factor out there.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

Well, so much for Churn Central. We're now officially into "The Wall of Worry: Credit Markets Edition." The market is pretty much daring the Fed to hike into this. I'm guessing a hike is still treated better than inaction, but clearly the equation is changing.

Anyways, it was quite the eventful week in CBOE Volatility Index (VIX)-land. Our favorite fear gauge popped 65%, thanks to a huge 3.7% drop in the markets.

Wait, what? That's kind of extreme, right?

Well, yes -- very. We're trending towards excessive reaction, but this is getting a bit much. I run a rolling 20-day average of the VIX:S&P 500 Index (SPX) correlation, and it's up to a quite robust -0.95. Last I checked, it can't go higher than -1.00, so we're at pretty much maximum turbo here. The 20 day lagging VIX:SPX multiplier is up to (really down to, but think absolute here) -9.98, which is on the path to the highs (lows) we saw in August.

VIX itself closed 38.26% above its 10-day simple moving average, which ranks 19th all-time in the 5,761 days the SPDR S&P 500 ETF Trust (SPY) has traded.

Generally speaking, it's been a good time to get long the market when VIX gets this stretched, with average one-month returns of 2.75% and three-month returns of 7.77%. I didn't winnow out here, so there's so duplication of data. But it's also worth noting that overbought VIX can beget wildly overbought VIX, like it did just this past August.

These pops are getting more and more common, by the way. As you can see above, six of the top 20 stretched VIXes have occurred in the last 15 months.

As far as VIX futures go, we're way more nervous now than in August. Here's the term structure Friday vs. Aug. 21. Keep in mind Aug. 21 was also a very ugly Friday, but also keep in mind that the actual VIX is 3.5 points lower now than it was back then.

We're about 3 points higher across the board in futures, with VIX 3.5 points lower. That's a huge uptick in fear. The iPath S&P 500 VIX Short-Term Futures ETN (VXX), which proxies a 30-day VIX future, was up 15% Friday, vs. the 26% VIX pop. It typically tracks 40-45% of the VIX move, and generally lower than that when VIX pops as futures price in mean reversion.

In other words, our "mean" assumptions have absolutely exploded. Roll it all together and we're in a huge fear burst here. VIX is reacting excessively to SPX moves and VIX futures, and pricing in some permanence to the VIX lift.

It's very, very, very tough to stand in the way when markets cascade. It's especially tough on a Friday. Perhaps the volatility markets are "smart" and it's about to get even uglier here. I would hardly be shocked to see this continue a bit. But odds are it's just too much extra fear too soon, and it's going to look oversold pretty soon.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.