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Summary Futures touched backwardation a couple times this week. Investors should realize their risk/reward before jumping head first into the shallow end of the pool. Markets appear to be normalizing mid-week. Feeling unfulfilled by the volatility tease? You’re not alone. Monday was the big headline this week with the market going gaga for Greece. By mid-week volatility ETPs had given up some of their gains but remained elevated. In this ultra-low volatility environment investors forget that the historical mean for the VIX is around 17. By simply reverting to the mean, the ProShares Ultra VIX Short-Term Futures ETF (NYSEARCA: UVXY ) managed to gain an impressive 40%+ at its peak on Tuesday. However, the pundits were out on Monday already saying to short volatility. I would just question the insight behind such as suggestion. Had you waited until Tuesday, you would have had a better opportunity. These types of one day scenarios are really a volatility trader’s best friend. The markets knew this was coming and still overacted. Economic data out of the U.S. continues to be good and if you have followed my past articles, I have always recommended looking to economics to guide your VIX trading. I continue to seek events that cause over 5-10% backwardation as the optimal risk vs. reward scenario. With that being said I did sell a couple UVXY calls on Tuesday. However, I really wanted this to turn into something more but it appears the market has other plans. Every tick the market took higher really just made me more angry. Can we please just get a good freak out already? In this article I will review the basics of UVXY and go over what I am watching for during the next few months. UVXY (click to enlarge) VIX futures did dip into slight backwardation during the week. (click to enlarge) If you are unfamiliar with volatility products, UVXY will gain premium when futures are in backwardation similar to how the ProShares Short VIX Short-Term Futures ETF (NYSEARCA: SVXY ) benefits from contango. For more information on these two terms, click here . UVXY invests in front and second month VIX futures contracts and will rise when futures rise. Ultimately it will lose value over time, which is why my strategy is to wait for a spike and then enter into short positions through options. It had been just shy of five months since backwardation presented itself. Outlook What this spike in volatility should have showed volatility investors is that market complacency is beginning to wear off. Monday was nothing more than a trigger happy reaction to news that had already been expected to happen. Given the positive economic data, I fully expect liftoff of rates in the September Fed meeting. Any slowdown in growth that coincides with rising rates could trigger another knee jerk reaction from the market. Even though we are in the expansion phase of the business cycle, in my opinion this market will tread water and possibly move slightly higher. If you look at the S&P action this year gains have been minimal and so has volatility. This has been despite record margin debt and record share buybacks from companies. Even more concerning to me is that some of these buybacks are built on margin! Companies will eventually have to repay that debt. What will be left to support earnings growth? Earnings growth is the bedrock of stock market appreciation. We will see an increase in EPS from buybacks but the higher stock prices go, the less effective buybacks become. It has been very quiet on the political front for a long time. Certainly there are angry countries out there preparing to go to war or not pay their debts? Although these things are poor for humanity they make for good volatility investment opportunities. Conclusion It was refreshing to finally have a down day in the market and see UVXY spike. However, traders should not instantly jump on these types of scenarios but rather let it play out a little to make sure you are making the right decision. I am looking forward to a much more volatile end of the year. October is the best month for volatility when looking at seasonality. You have the Feds on deck in September. Too bad the government isn’t shutting down this year. That sure was fun and profitable. Eventually the market will have several tragedies coincide with one another and it will make for a more profitable opportunity to short volatility. Those that entered trades this week, best of luck and remember to manage your risk. I am still at 80% in cash just waiting for a better opportunity in the VIX futures market. My retirement portfolio is performing well with my Citi (NYSE: C ) recommendation but suffered from my Micron (NASDAQ: MU ) purchase before earnings. I was able to cut losses after earnings but my performance for the year resembles that of the S&P 500. Sometimes you just need to be able to look back and realize you made mistakes and move on. Going all in on a little spike in volatility may be profitable a couple times but it will eventually come to bite you. Patience is key, especially in this market environment. I understand that you have to take what you can get, but always remember that capital preservation is your number one priority. Best of luck to you in the coming months! I look forward to getting back to volatility analysis. For free real time updates you can follow me here on Seeking Alpha and on Twitter. Often times during these events I only have time to write an Instablog, due to editing times. If you aren’t a real time follower it will not notify you of Instablog posts. Disclosure: I am/we are short UVXY. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Only a couple calls short on UVXY Scalper1 News
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