Speaking of thunderous roar, I attended the jam-packed NIRI Rocky Mountain Chapter’s kickoff session today. Nasdaq chief economist Frank Hatheway offered a thoughtful and statistical look at the market. He joked that when he first prepared slides two weeks ago, the trends were improving but he’d had to change his comments to reflect reality.

Dr. Hatheway launched his talk by comparing stock indices with VIX volatility, Treasury yields, oil prices and gold. He observed that investor-relations professionals today need to develop a level of understanding of these “macro factors” – benchmarks of group behavior across asset classes (clients, we include a Macro Factors segment on page two of your Market Structure Report).

It was a chunky nugget I wanted to share. Get to know macro factors. Use these events to shape tactical outreach. If a macro factor like VIX volatility is deteriorating ahead of VIX futures expirations, it’s going to affect both risk hedges for major institutional holders and speculative trading by those chasing mathematical calculations of divergence. Call your deep-value holders ahead of time. If you’re on their minds, maybe they buy the dip.

Plus, the IR chair is in some ways today like the chief economist for each company. You’ve got to have your hands on data, trends. Why? It’s how markets work. If you want to know the outlook for your economy – the market for your shares – you need to understand what behaviors and trends drive it. As Dr. Hatheway noted, discounted cash flows still form the basis for asset value. But macro factors create the discount rate, in a sense, which can change quite dramatically how your shares are assessed in diversified portfolios or as liquidity in speculative models. Both are legitimate activities in your economy – your equity market. But you should know what role they play.

Often, rational money is out of step with market realities too. Today I reviewed data for a large real estate company and noted how rational money bought ahead of options expirations in August, just as trend traders and risk managers cashed out and shifted to derivatives. If IR professionals can avoid being caught flat-footed like that poor investment manager, well, you look smarter, cooler and better in the IR chair.

And that’s good job security in an economy that Dr. Hatheway thinks will grow about 1% next year.

Two quick reminders: Options expire, including VIX futures, Sept 14-16. And we’re sponsoring IR Magazine’s Think Tank session Nov 3 on tracking trading in the IR chair. Join us!

It’s the trading symbol for the iPath Long Enhanced S&P 500 VIX Mid-Term Futures ETN. We saw the circular from Direct Edge, where it began trading today. It’s not some cheese ball confection lofted by off-shore subsidiaries of Boca Raton broker-dealers. It was created by Standard & Poor’s. It’s underwritten by Barclays.

VZZB is an exchange-traded note (ETN), an uncollateralized debt obligation backed by Barclays that trades like a stock, leverages returns, depends on volatility and consists of futures contracts that mimic the supposed future volatility of an index. For gains.

Why should you care, sitting there in the IR chair? Eight of ten days, your stock is moving because somebodies speculated on the divergence of this versus that, or some other bodies tweaked their risk-management schemes to offset increasing implied volatility. Or whatever. It’s all interrelated. If you want to know why your stock behaves the way it does, you must see it in context of how markets work and what behaviors drive supply or demand in your shares.

VZZB’s name says it all. Literally. First, it goes long its components, buying them, not borrowing them and selling them short. Second, it’s “enhanced,” which means it’s using options to outperform the benchmark – for a day. Third, it’s based on the S&P 500. Fourth, it’s really derived from the VIX, the Chicago Board Options Exchange’s wildly popular measure of the implied volatility of the S&P 500 index (VIX options expire the 20th in the middle of earnings). And finally, its components are daily rolling VIX futures contracts four, five, six and seven months out – the “mid-term” – that simulate volatility at various points in the future.

Yet it offers correlated, enhanced returns today. Just a day. And realize this: There is an options chain for this instrument. You can trade puts and calls on this derivative, comprised of derivatives of derivatives, and their implied, leveraged volatility.

Need to help your CFO see why your stock sometimes does the craziest things? Say to him or her: “Look up this ticker, VZZB. Read how it works. Now think about the mindset that invests in volatility as an asset. It’s not fringe behavior. VZZB’s first cousin VXX regularly trades 30 million shares daily.”

Lesson for the observant: Barclays thinks market volatility is back. A Barclays executive said of the launch, “We continue to see investor demand for exposure to volatility…”

And there you have it. Money is buying volatility as an asset class.

NOTE: See the update on the Issuer Data Initiative at bottom.

Citigroup, market cap $129 billion, plans to trim its 29 billion shares with a 1-for-10 reverse split. Citi float mushroomed from 5.5 billion shares when the U.S. government injected cash through warrants that converted to shares, which the Treasury then unloaded through Morgan Stanley while the Fed quantitatively eased the markets to solid gains.

Resisting the gravitational pull to ask rhetorically why government has power to print monopoly money, pump up its own outcomes, and put paper into one bank but not another, let’s make this Part Two of “lessons in liquidity.”

Last week we discussed the very antimatter to Citigroup, Berkshire Hathaway. BRK.A trades about 500 shares per day, mostly on the NYSE, without high-frequency trading (HFT), for about $127,000 each. There are 1.6 million shares out. Its beta coefficient, a measure of volatility, is lower than every Dow Jones Industrial component save Wal-Mart.

Meanwhile, Citigroup became the mother of all trading securities, averaging over 450 million shares daily – easily the most active stock of all. It’s five times more volatile than BRK.A. On January 18 this year when Citigroup (NYSE:C) reported results, its stock traded about 1.9 billion shares, some 35% of total NYSE volume that day.

Justin Schack, who heads market structure matters for the smart folks at agency trader Rosenblatt Securities, told the Securities Technology Monitor that Citi’s reverse split could reduce total volume in US trading markets by 5%. And since C is a major force behind options contracts, those markets could take a hit too.

Why? Because much of the volume in Citigroup comes from “furnishing liquidity.” That’s HFT. Without disparaging the architects behind paying traders to trade (similar to inflating your currency because prices are falling), this volume is not real. Exchanges pay liquidity providers to attract and keep the best bid or offer so they can earn revenue from the consolidated tape (see Issuer Data Initiative, again).

Suppose 80% of trading in Citigroup is HFT. These shares just move from Citigroup’s Designated Market Maker Barclays, at Post 8 Panel U, through Supplemental Liquidity Providers like Getco, Goldman Sachs and Knight, and around to proprietary traders executing at BATS and Direct Edge, to mix with the retail volume at Penson, Citadel and others.

This behavior literally distorts itself. If the shortest distance between two points is a straight line, this trading market looks like a skein of yarn meeting a basketful of kittens.

Citigroup is a broker-dealer. They know trading. And they’ve decided to reduce liquidity by 90% when conventional wisdom says preserve liquidity, like gold.

What if we just pressed pause? I’ve personally argued that more liquidity is better. But maybe a small amount is best. In real estate, it is. Suburbs have high beta. Beaver Creek does not. If gold is your medium of supply fitted to demand, a Ford Taurus and a two-piece men’s suit today cost exactly what a suit and a Model T cost 100 years ago.

Maybe all public companies should trade for $100,000 per share. Would that kill the Citigroup effect?

Speaking of data, thanks for your growing support for the Issuer Data Initiative. But “thank you” isn’t correct. It’s your data. Information about your shares has gone missing in gobs and bunches via the consolidated tape. Let’s drag it back into the light.

If you haven’t yet committed support, do so today.

Speaking of conversations best had around adult beverages, no doubt many of you have laid awake nights wondering, “How does relative value arbitrage work, and should I care?”

First, arbitrage isn’t bad. It’s a path to both profit and protection. Universa, the hedge fund advised by The Black Swan author Nassim Taleb, follows relative-value arbitrage techniques to help clients offset risks (Incidentally, Nassim Taleb remarked about the May Flash Crash that when a bridge collapses, you don’t study the last truck that crossed it; you look for structural flaws.). So the first thing to know is that gaps, or spaces, between things offer chances to profit from spreads and opportunities to guard against an equal but opposite risk. And this stuff will at some inevitable point affect the price of your stock, so it’s best to know about it.

Any trading strategy that focuses on the spaces between things rather than the things themselves is a form of “relative value” arbitrage. Global Macro strategies dominated hedge-fund investment in the 1990s, accounting for roughly 80% of assets under management. It’s not new. And it’s a form of relative value arbitrage. Global Macro techniques are widely used today, except at high speed now. For instance, have a look at indices from structured-products broker Newedge for volatility and macro trading, and you’ll see that they’re predicated on fairly small returns – and losses. Lots of little returns at nominal risk make sense when uncertainty abounds. So it becomes common in stocks too.

Let’s use you as an example. Say your stock trades for $20 right now. A trader with a relative value arbitrage strategy might buy an option, either on your stock or for an index, and then sell your stock for a “long” volatility position. Buying your stock (the underlying asset) and selling the option instead is a “short” volatility position, because the trader is short the potential, or implied, volatility. The trader profits in a long volatility trade if your actual volatility is greater than the implied volatility of the option.

Now that sounds complicated, and it can be. But realize that it’s about the volatility, not your price or the price of the option. Think about it this way. If your volatility is 25% over the life of this trading plan, while the volatility of the option is 20%, that’s a profit, regardless of what caused the spread.

Now suppose the trader is a “liquidity provider” too, offering shares for sale. Now the trader might be able to “move” the price of your stock with high-speed trades, while also holding a volatility play. This is fairly common. If your stock moves from $20 to $18 and back in a day, that could be enough for the trader to profit. What’s more, say you trade five million shares a day and the trader sat between 300,000 shares of that volume with a machine. The trader might’ve pocketed $1,500 on this activity too, as gravy. Duplicate that in a portfolio trade of 30 liquid stocks and combine it with relative-value arbitrage plays, and pretty soon you’re talking real money that’s almost as easy as a government bailout.

So what do you do about this? No, the point isn’t what you do, but whether you understand what’s going on. If your stock’s price moves a great deal intraday but not a lot by the close, there’s a reasonable chance that traders are engaged in relative value arbitrage. And simply having that answer when the CFO stops you in the hall may be the most important thing for now.

Speaking of power outages, starting April 22 equity markets developed voltage problems. IR professionals, we’ve got two words for when you meet the CFO in the hallway and she asks, “What’s up with the stock market?”

Risk Management. What two words did you think we were going to offer? “Risk Management” is why the same stocks that were up yesterday can be down today. We saw surging European and Asian inflows April 22, and a reversal of the same inflows on April 27.

From the IR chair, it’s flummoxing. Your nearest peer, in the same industry, about the same market cap, doing similar things, reports results on April 22 and beats expectations and soars 10% in a day. You then report the same good results almost pound-for-pound, a handy beat. And your stock declines three percent.

What gives?

Time for those two words: “Risk Management.” Large portfolio trading schemes such as pension and investment funds may hold an array of securities. Let’s say euro-zone bonds, currency futures, US Treasuries and US growth stocks. Suppose these investments are protected with risk metrics software from SAS, and trading-desk level systems from prime brokers JP Morgan and Deutsche Bank. These systems are designed to monitor and maintain portfolio risk and return within certain parameters.

Greece’s bailout is approved. The systems determine that this will strengthen the US dollar, thus weakening inflows to US equities from European and Asian sources. The systems themselves execute automated trades, complete with offsetting derivatives, to control risk.

This behavior causes a domino effect. The same securities the system said to buy last week are now the ones it sells. That triggers other limit orders and stop-losses, changes the nature and size of passive market-making trades, and attracts statistical arbitragers finding fleeting imbalances. And because ONE variable in the overall risk-management schematic is different – maybe a risk metric is the ratio of dollars on reserve at the European Central Bank, which has just returned a bundle of them to the US Federal Reserve – it over-corrects.

The next day, the system tries to rebalance the overcorrection, producing a spike in US securities again. Commentators bray about renewed enthusiasm for US economic growth, which in fact plays almost no role. Leveraged ETFs had just today adapted to yesterday’s big risk-management change. Now those are out of balance.

Suddenly, inefficiencies abound. Passive market-making systems aren’t getting liquidity to the right spots fast enough. Stat arbs are executing simultaneous offsetting trades in ten different market centers, creating the illusion of movement where none exists.

And the next day, the risk-management system tries to rebalance again.

This is how you get great volatility in markets designed to function smoothly and efficiently.

You don’t need to explain it in detail to your CFO. But you should be able to say, “We have integrated global markets. Our results, which were great for our active investors, now are secondary to global risk management. That’s the reason we’re under pressure. It’s a portfolio problem.”

But portfolio problems are our problems too. What’s the answer? We invite your suggestions. Meantime, be sure management doesn’t take it personally. It’s not always about you.

Remember that Redford flick from the 1970s, Three Days of the Condor? It’s a thriller about high-level conspiracy. In volatility trading, an Iron Condor is not conspiratorial, just an income trade. You sell two puts and buy two calls, with the spread between both always giving you an initial credit in your account (your highest possible return). If the underlying issue, say an individual stock or the S&P 500 Index, the SPX, trades between your puts and calls, your options expire and you keep one or both credit spreads. It’s a popular thing to do in sideways markets.

Since the SPX converted Dec 24 from the June 2009 version to the next iteration of the S&P 500 Index (it’s called the SPX converting to the SPL), the three days before that might’ve been a deliberate effort to put a squeeze on some Iron Condor traders. Why? Quiet markets. No news is good news if you’re trading for a credit profit. Money’s on the sidelines.

Instead, the “Vega,” or unexpected volatility, increased. Was it chance, or did counterparties take advantage of the situation and push some Iron Condors into the money, forcing them to cover and pay rather than keep their credits? It’s possible. Also, Iron Condor is a pretty good name for a rock band.

Now, why would you care about Iron Condors, IROs and execs? Because once again something besides fundamentals affected market prices. The cool, contemporary and confident IRO has got to know market structure. If you thought it mattered in 2009, wait till you see the variables lined up to hit the 2010 markets.

Here’s one. If you wanted a swear word this past year that reflected something infinitely venal, you would mutter sharply, “auction rate securities.” Yesterday, the Federal Reserve announced that it would offer term deposits to banks through periodic auctions to try to bleed some of the $1-2 trillion of excess, created cash out of the system.

In the private sector, manufacturing an artificial means to deal with excess cash is called “money laundering.” But the Federal Reserve is counting on banks to park cash with them at your expense next year, since interest will be paid on these manufactured deposits.

The point is, what happens if banks use the new government auction-rate market instead of trading with that excess cash as they did in 2009? We don’t know. It’s a Vega Risk. Vega risks abound.

We actually think 2010 could be a ripper of a year in equities, at least for awhile. Why? It’s less risky to trade with money than to loan it into economies dictated by regulations and monetary policy. Loaning requires a term and performance by another party. Trading you can do any given day and end flat, and you can take advantage of what other people do, instead of depending on them. Maybe with some laddered Iron Condors.

Wry humor to end 2009! Have a fantastic New Year, and we’ll have more to say in 2010.