Avoiding Panic: Keep Your Head And Look To Short Volatility
U.S. stock market performance has taken a turn for the worse in the week of August 17. Volatility has risen dramatically for several reasons, including China currency actions and expectations for near-term Fed action. SVXY, the ProShares Short VIX Short-Term Futures ETF, has taken a hit as volatility has spiked to levels not seen since 2011. Rising volatility represents an opportunity to find an attractive entry point in SVXY. The U.S. stock markets have proven remarkably tame in 2015 until the recent volatility in August. From the beginning of the year until the middle of August, the S&P 500 had risen 1.6%. However, this past trading week, from August 17 to August 21, the S&P dropped almost 6%, leaving the index at a 4.3% loss for the year. While market reactions can never be predicted in advance, the pundits can often retrospectively flag the reasons, namely China’s currency actions, North/South Korea war games, the Iran deal, you name it. During this same week, volatility, as measured by the VIX, sky rocketed, starting the week at the mid-14s and rising to nearly 28 at the close of regular trading hours on Friday, nearly doubling. The VIX rose more than 45% on Friday alone. ^VIX data by YCharts At this level, the VIX is reaching territory not seen this year, and looking back, not since 2011. ^VIX data by YCharts While spikes in the fear gauge are event-driven, in the background, the U.S. economy is chugging along, with slow but moderate growth, the hallmark of the economic recovery over the past 5-6 years. US GDP data by YCharts This slow but steady economic growth, along with the decrease in unemployment rate , creates positive long-term economic trends for the U.S. We have been in a bull market for a number of years, and the rise in employment, along with the rising dollar creating lower priced foreign goods, should continue to provide for slow but steady economic growth. Therefore, the spike in the VIX represents, yet again, an opportunity to trade in volatility and seek to capture short-term gains. While there are several ways to play this, my preferred approach is to trade in the ProShares Short VIX Short-Term Futures ETF (NYSEARCA: SVXY ). SVXY dropped over 16% on Friday August 21, to 70.39. While this is not a low for the year, as a short VIX vehicle, traders can opt to stage their buys into SVXY to capture the eventual decrease in volatility when the latest threat blows over. Now the “pressure” on SVXY to rise or fall depends on contango or backwardation, and several Seeking Alpha authors have written great articles about them, so there is no reason to summarize the issue further. Looking at contango or backwardation is the logical approach for short-term traders and after the dramatic rise in volatility, the VIX will be backwardation. While SVXY is generally viewed as a short-term vehicle, there is no denying that over its history, a 5-year buy and hold would have generated great returns. SVXY data by YCharts However, the volatility of this volatility vehicle is outstanding with the potential for significant draw-downs. It would require immense discipline to hold SVXY for the long term, given human behavior – you would literally need to put money away with no access possible for a decade or more. But if done, it could be highly profitable – and one great article suggests that over the long term, if one could hold and avoid trading in SVXY, huge amounts of wealth could be generated. While each investor needs to invest according to his/her own philosophy, timeline and risk tolerance, seeking an opportunity in SVXY when it spikes has proven to be worth a look. Disclosure: I am/we are long SVXY. (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.