Yo, Pit Crazies,
Trading involves accessing short term risks for potential capital gains.
If I am an options buyer, I want explosive possibilities. If I am an options seller, I want a quick collapse in option premiums.
Right now, traders are stuck on the fence about what is to unfold: will option premiums implode or explode?
They already jumped a bunch from Thursday to Monday.
The impetus is as old as recorded time. As a matter of fact, as old as a Bristlecone Pine Tree: 4000 year old trees that have bent and bowed to the extremes of the weather in the mountain range just East of the Sierra Nevada in California. I spent some of my youth wandering around the White Mountains and these funky bent trees.
Most of the tree is dead, but part of it is very alive. A broken bank is similar.
The Fed, FDIC and Janet Yellen blinked big time after some tough talk on Friday. While I do not know the reason for the about face, it might rhyme with “shmolitics”.
Silicon Valley Bank (Ticker: SIVB) has a lot of heavy donors that stood to lose hundreds of billions of dollars.
Will the Fed and FDIC change things forever?
The VIX Curve Is Crazy Flat
The issue here is conflicting signals.
I started my option trading career in 1989 in S&L Crisis. Back then, S&Ls went bust and deposters got back what was insured. All the assets went to a special purpose vehicle (SPV) run by the FDIC to sell all the broken properties and securities.
As of this writing, the big announcement was to make depositors whole far and above the FDIC rate of $250,000. The Fed will take securities as collateral and provide cash for instant liquidity. That should control some fallout in the short term.
SVB had a huge interest rate liability, and it’s hard to believe they left that unhedged. That created a huge SPX selloff and VIX rally.
Banks failing is nothing new, like I outlined above; financial crises are as old as recorded time.
However, now we have tools to measure the depth of the crisis. As of right now the flat VIX curve above says VIX can move hard 3-4 points in either direction. It was up 4 points from the closing price alone at one point Monday.
If the VIX curve has straight backwardation, I would be much more bullish.
If the VIX curve was in contango, I would be much more bearish.
It’s in between so traders are much more “undecided” as to the short term direction of VIX and SPX for that matter. It defies imagination that the Fed could add liquidity on Tuesday and take it away next Wednesday with a 50 basis point rate move.
That does not mean it will not happen … thus the curve indecision.
I think the flat VIX curve says the Fed will “pause” hikes for a while so they can see what they broke in the banking sector.
Broken banks are a sure way to slow down the economy, and the Fed has two so far. If they do hold rate hikes, I can see SPX back to 4000 easily by March 22nd. VIX would work the opposite way to the low 20’s.
The long term consequences are more unknown but likely to lead to more reckless risk taking. After all, SVB has the honor of having a Lehman alum high in their executive ranks.
Clearly they learned nothing.
To Your Trading Success,
AG