Last week, we wrote about the steepness of the CBOE Volatility Index (VIX) futures curve and what it may portend about investor expectations for the coming months. We noted that the curve was about as steep as it was in the weeks leading up to the election. At that time, the election was expected to induce a volatile reaction, and that proved to be generally correct. Although I stand by my hypothesis, that investors fear a “buy the rumor, sell the news” reaction to the passage of the stimulus bill, I add another factor to that theory.

What struck me most is the timing of the bump. Consider the chart below. The curve has flattened, but that is largely because spot VIX rose in response to this morning’s sharp selloff, not because of a diminution of future concerns.

VIX Futures Curves – Today (green), 1 Week Ago (orange), 1 Month Ago (blue)

Source: Bloomberg

Notice that the bump begins in earnest with the April futures. Is there anything else that is on the horizon for investors in April? I’ll give you a hint: like death, they are inescapable. Yes, April 15^th is when taxes are due.

Successful investing, and especially successful trading, creates taxable earnings. Last year’s spectacular rally certainly created gains for those who participated – as long as the investor realized some of his gains. The issue is particularly acute for those who used options and other short-term trading methods to create gains. By definition, those are short-term and are taxed as ordinary income at the filer’s rate. When we think about the remarkable rise in stock and options volume, we must assume that a fair amount of those trades led to realized profits for those who created that volume. And that could create a problem for the market.

Let’s think about a new investor. If he simply bought and held, he is likely to be sitting on gains, and many of those will be non-taxable. Gains only become taxable when someone sells a profitable investment. Yet I find it hard to believe that most of the volume that we have seen was simply by “buy and hold” investors. Trading has become a popular pastime, and a potential taxable event is created each time a trader exits a position. Let’s say that the new investor in our example was actually a profitable trader. He is now potentially liable for a significant amount of taxes that need to be paid.