Bill Luby Talks to OptionPundit
Bill is a private investor who also authors the VIX and More blog and an investment newsletter from just north of San Francisco. His research and trading interests focus on volatility, market sentiment, technical analysis, and ETFs. Prior to becoming a full-time investor, Bill was a business strategy consultant for two decades and advised clients across a broad range of industries. Bill has a BA from Stanford University and an MBA from Carnegie-Mellon University.
Bill and I started blogging almost at the same time. Bill has been spending considerable time on VIX and related products. He has done tremendous work in this area. Recently I requested him if he could share his knowledge/ insights on VIX with OP readers. I am thankful to him for sharing his opinion and providing quality answers to OP reader’s questions.
I asked many of the questions on behalf of OP readers. In the interview text below “OptionPundit” means OP/ OP reader.
OptionPundit: Bill, Thank you for accepting the offer. It’s a pleasure to have you.
Bill: Thank you.
OptionPundit: Tell us how a new user could use VIX-and-More blog that is full of rich content. Assume the user doesn’t have much time. What are the top 10 posts that one MUST READ?
Bill: A lot depends on your knowledge base. By far the most popular post I have ever written is an introductory one, Ten Things Everyone Should Know About the VIX. I have tagged some of my personal favorites with a “Hall of Fame” tag. I have also archived the top 25 most read posts for 2010, 2009, 2008 and 2007. You can also search for your favorite subject by label. Since the launch of VIX-based exchange-traded products, the issues related to these products have by far the most popular. You can look for keyword and subject matter tags for these and other subjects. Some of the more important ones, in my opinion, are term structure, contango, VIX futures, VXX, etc.
OptionPundit: What is the best way to hedge a short or long position in VXX?
Bill: A VIX futures position is probably the most accurate way to hedge a long or short position in VXX, but my answer depends partly on the term structure of the VIX futures at the time you intend to hedge your position. If you have roll yield in your favour (long VXX while in backwardation, short VXX while in contango), then a front month VIX futures or options hedge is usually a good bet. If the term structure and roll yield are against you, consider looking at some of the further out months or using a mid-term VIX ETP like VXZ.
OptionPundit: What is the best way to hedge the IV component in an options spread?
Bill: This is an interesting question for me in that typically the IV component in an options spread is where I am looking to make my money rather than hedge, so I am not sure I am the best person to answer this question. My general answer depends on whether your IV exposure is long or short, the shape of the skew, etc. — so you can hedge by going farther OTM or into more distant months; you can also mix vertical and horizontal spreads.
OptionPundit: How do you think volatility best compliments an equity portfolio?
Bill: In my own investing, I treat volatility as a separate asset class that is largely uncorrelated to other asset classes in the long run. For most investors, volatility is a good balance to equity positions, since it generally moves more sharply in the opposite direction, at least in the short term. For some ideas on hedging with VIX products, check out Edward Szado’s VIX Futures and Options: A Case Study of Portfolio Diversification During the 2008 Financial Crisis.
OptionPundit: If you thought the VIX was oversold, would you rather buy an SPX straddle or long VIX calls?
Bill: Given the choice between buying SPX straddles or VIX calls, I generally prefer to buy VIX calls, but that is largely a matter of personal preference. SPX/SPY straddles have even greater liquidity than VIX options, so you could certainly make a case for preferring these to VIX products on the grounds of liquidity.
One instance where the difference between long SPX straddles or long VIX calls would be in the case of distant options and/or LEAPS, where you can make the argument that a big move in the SPX is more likely to turn into a trend, whereas a big move in the VIX is more likely to revert to the mean.
OptionPundit: Is it cost effective to duplicate VXX with futures. Commission, spread etc.
Bill: It can be cost effective to try to replicate VXX manually, but a lot depends on your rolling strategy and brokerage costs for VIX futures. Whether it is worth the effort may be the more difficult question.
OptionPundit: If you were to try to duplicate VXX with futures, do you roll at the close or the open?
Bill: Since VXX rolls at the close, rolling at the close gives you a better chance of mirroring VXX exactly. If your goal is not to mirror VXX, but to improve upon it, you may come up with a dynamic rolling strategy where you are not forced to roll every day, but can choose to roll on those points in the cycle where you think you can minimize the cost due to a temporary advantage in the VIX futures term structure.
OptionPundit: With the volatility skew present in SPY, could you use a short collar (short stock, short Puts, long Calls) continuously as a hedge?
Bill: The volatility risk premium in SPX/SPY makes long puts expensive, so I generally like any strategy that is short these puts and your short collar idea falls into this category.
OptionPundit: There have been numerous discussions about volatility and related products e.g. SKEW, CSFB fear index, VIX, VXX, VTY, TVIX, VXZ and many more. Could you please share which are worthwhile learning and using for investment for a retail trader like me. What is the best way to develop and understanding of these relatively complex products?
Bill: I think a retail trader should start with the basics. By this I mean the VIX and VIX futures. Once you understand those products, the VIX ETPs (VXX, VXZ, etc.) will make more sense. I think the SKEW and CSFB have a much more limited application than VIX products. If you are going to study the VIX and volatility, one related subject to look at would be put to call ratios.
OptionPundit: What do you think are the key success drivers for making money “consistently” from stock market.
Bill: I tried to map out some of my thinking on this subject when I created a Trader Stage Development Model. I think there are several foundation skills/assets, including the ability to develop strategies that have a persistent statistical advantage (“edge”), the ability to manage a stable of existing strategies and strategies that are in development/refinement, risk management, psychology/personal factors, etc. I think most traders/investors could benefit from additional analysis about the extent of the edge they have, position sizing, and money/risk management.
OptionPundit: What kind of trading strategies would Bill will recommend as most suited for these (now and say the next 6 months) volatile times?
Bill: One of the best things about volatility is that it cannot remain at extremes for an indefinite period of time. The more volatility is at an extreme level, the more opportunities there are. For the next six months or so, I would look at opportunities to short volatility, capitalize on fear that is out of proportion to the fundamental economic challenges, and be able to be a contrarian when the emotional content of the markets is much higher than usual – whether this means long or short opportunities.
OptionPundit: If Bill were to trade directionally, which technical indicators would he use? Under what circumstances will Bill take directional trades?
Bill: I trade directionally a great deal and use indicators that incorporate volatility, momentum, market breadth (advancers minus decliners, etc.), volume and other market sentiment data – on top of some more traditional technical analysis. Fundamentals and valuations play a much smaller role in my trading than the analysis of market sentiment and technical factors.
OptionPundit: There are many volatility related indicators; could you please suggest a few that one can use effectively?
Bill: I have used quite a few volatility indicators, but the VIX is at the top of my list. Look for volatility wherever the main concerns are, such as Europe (VSTOXX, etc.), financials (XLF IV, etc.), gold (GVZ), etc. Often overlooked is VXV, which measures 93-day volatility and often gives a much better measure of systemic risk than VIX.
OptionPundit: There have been numerous discussion on Historical Volatility and Implied Volatility. Could you please suggest how best to use these two measures? What conclusions one can draw by knowing the two volatilities? i.e. when HV >IV, HV<IV, HV=IV?
Bill: This is a huge subject that I am not sure I can do justice to with a short answer. I think one might be better served by comparing current IV to prior IV than current IV to current HV, at least for starters.
OptionPundit: Under what market conditions buying strangle on volatility would be a good trade.
Bill: The simple answer is that when IV is historically low, but a lot depends on which underlying you are talking about and what corporate/national/global events are on the horizon. It is also possible to make good money on a strangle where IV is high, but is trending higher. Ultimately, the ability to forecast future volatility better than the market is the issue.
OptionPundit: The strategy from which the XVIX product is based has performed poorly since ETN inception. Granted returns in 2010 were “insanely good”(particularly risk adjusted), can you provide insight as to why mid-term (VXZ) leg of this trade has unwound so much in recent history? Is it because the market perceived us no longer being “systemically risky” which would bring an end to former volatility regime? if so are there any hints in term structure or otherwise (macro or technical) that can give us a wink as to when it is a potentially favourable environment to be in(out) such a product?
Bill: Up until late September, XVIX has been struggling due in part to the fact that the roll yield for the mid-term portion of that holding (i.e. VXZ) has been much more disadvantageous than historical norms. Since then the roll yield for the mid-term leg has been improving, but XVIX still has a lot to prove before I can get excited about it. One important aspect to watch is the roll yield of the mid-term leg vs. the short-term leg, which will be an important determinant of long-term returns.
OptionPundit: I have gravitated towards using volatility based products to hedge equity exposure as opposed to traditional index puts (which are often priced dear). I recently did very well with a call -1/+2 backspread on VIX eurostyle options, but the liquidity of the VXX, VXZ products is tempting. Do you see an edge/advantage to playing such hedging strategies on the ETN options or VIX options? What about hedging using VXX/VXZ underlyings directly using concepts like Barclay’s vector strategy?
Bill: The VIX futures term structure will largely determine how well VXX and VXZ perform relative to the VIX – particularly over the course of longer time frames. Personally, I have a tendency to favor using long VIX calls when VIX futures are in contango and long VXX calls when the VIX futures are in backwardation. I like the concept of the Barclays vector strategy, but would generally prefer to use VXZ as the volatility leg, due to term structure issues.
OptionPundit: What are available resources paid/free that one must start using.
Bill: I am essentially 100% self-taught in all things options, so my opinion is that just by reading information from the CBOE, OIC, options blogs, etc., one can get a fairly good grounding in the options basics and much of the more advanced material. Similarly, the options brokers have excellent educational webinars, etc.
I have never used a mentor, but this could certainly get you up to speed faster. I am not familiar with various options courses that are taught, but I’m sure some of these are worth checking out.
A good options library makes an excellent reference. Everyone should read the likes of Natenberg, McMillan, etc. I am also a co- founder of an options magazine: Expiring Monthly: The Option Traders Journal, which tends to focus on articles for the intermediate to advanced options trader.
OptionPundit: Thank you for your time Bill. On behalf of all the option traders, I sincerely appreciate your sharing. Hopefully the insights you shared will help retail option traders in building their own toolbox to deal with current state of markets and achieve better winning consistency. I look forward to future conversations.
Bill: It was a pleasure talking with you. I also look forward to future opportunities.
Dear readers, I hope you enjoyed the interview and found some insights that might help in your trading. If you have any feedback, comments, suggest, follow-up questions, pls post it here in the comments section. I shall follow-up with Bill to respond those.
Profitable Trading, OP