Volatility Is Whipsawing Investors, Which Side Are You On?
Volatility has been swinging wildly in recent weeks. This provides investors with trading opportunities but the risks are large. I’ll outline my forecast for volatility and what side of the trade I’m on right now. A couple of weeks ago I wrote about how I was taking the plunge and shorting volatility by proxy using the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ) and its inverse ETP, the VelocityShares Daily Inverse VIX Short-Term ETN (NASDAQ: XIV ). I’ve been trading in and out of volatility since the flash crash of last October and while I’ve had pretty good fortune, trading volatility is not for the faint of heart. The moves are swift and brutal and if you’re wrong, you’ve got to be willing to move quickly. Sometimes that means taking a beating in the process but living to fight another day because the profits can be huge if you’re on the right side of the trade. Last time I visited volatility I was, as I said, shorting it. Another VIX spike had just occurred and I took the plunge and shorted the VXX via XIV, the inverse ETP to VXX. I shorted the VXX by selling my long VXX position at $36 and buying XIV at $26 on the same day. It turns out that was a decent move because, as you can see below, the spike end that day. (click to enlarge) I rode the plunge in the VXX to a price of $29+ on the XIV before taking profits and as we can see, the VXX bottomed a short time after. If we fast forward to last week, I actually took a long position in VXX at $31.60 and put on the same covered call trade I outlined for you in early January . This is my preferred method for getting long volatility for two reasons. First, in case you’re wrong, you have some cushion to the downside. And while a full-blown meltdown cannot be fully abated with call premiums, it helps. Secondly, when volatility is high like it is now, premiums on the VXX are downright enormous. You can collect a 3%+ premium for a weekly call that expires in five days when implied volatility is high. That’s how you put the odds in your favor and that’s how I like to play VXX. On Friday, as volatility spiked once more, I sold out of my profitable VXX long position and subsequently went long the XIV, thereby shorting the VXX, on Friday morning at a price of $27.25. As it turns out, I was way early on that move, as the VXX finished the day roughly 8% higher than where I began shorting it and that’s why it’s important to understand the risks when trading volatility; the moves can be swift and huge and cause eye-popping gains and losses in the process. However, I’m undeterred by a few hours of action and as long time readers will note, the first time I shorted volatility in October started out much the same way with large losses that eventually turned around. Of course, I don’t have a crystal ball but I feel that traders are getting tired of the negativity at that while I obviously missed the top, I think I was somewhat close. As for this week and the coming weeks, I don’t see a lot of real negative catalysts. The oil crash story is getting old and the worries about deflation, while well-grounded, can only dominate headlines for so long. The ECB and the Fed continue to bazooka money into the markets whenever somebody sneezes and that means volatility spikes should be met with some buying interest and buying interest means lower volatility. Of course, some unexpected event could arise but that is true 100% of the time and not exclusive to current circumstances. My outlook for volatility is that we’ll see it die down in the first week of February and depending on when the cool down period happens, I’ll look to make my move out of XIV. But for now, I’m short volatility because the VXX at $37 is not a sustainable condition. Granted, VXX may go much higher than it is now and if it does, I’ll add to my short position but at $37, I’m willing to take a bet that the top is near. If we take a look at the chart above we can see a very well defined channel that the VXX has been trading in since December and with shares nearing the top of that channel, that’s why I’ve gotten short. I wish, of course, I’d gotten short $2 later than I did, but those are the breaks sometimes. So while I’m currently sitting on a very fresh, very painful loss on my short position, the chart gives me lots of hope that the losses will be short-lived. I like a short VXX position down to $32 or so and maybe lower depending on how long the selloff takes when it happens, because it will; it always does. I think investors are facing fatigue from the negativity and that fatigue will lead to an exhaustive blow out of volatility, which, just maybe, is what we saw on Friday. Either way, I think lower volatility is headed our way. Disclosure: The author is long XIV. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.