VIX ETN – The Foolproof Way to Short the Market

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I’m sure you have traded, or at least heard of, inverse exchange-traded funds (ETFs) that go up when the index it tracks declines. But the problem with them is that the market can just keep moving higher and higher, causing the ETF to trade lower and lower until, finally, the inverse ETF moves so low that a decision is made to “reverse split” the thing so the price doesn’t make the ETF seem like garbage.

Take Direxion’s triple-inverse financial ETF, Direxion Daily Financial Bear 3X Shares (FAZ).

FAZ, which seeks 300% of the inverse daily performance of the Russell 1000 Financial Services Index (RIFIN), saw a sharp decline in 2009. As financials had a sharp rebound, investors who took bearish bets by purchasing FAZ at $200 saw the ETF move down to $5.40. 

The ETF had a 1-for-10 reverse split, leaving it at $5.40. But back on July 9, it was priced at $55.40, and if you owned 100 shares, you ended up with 10 shares (so the value of the position remained the same). Since then, it’s traded further down from $55.40 to $11.65 (which means, pre-reverse split, it went from $200 to $1.16).

While the moves seen in this triple-reverse ETF are rather dramatic, those in the double-inverse (“ultra”) ETFs are less so, and even less so are the regular inverse ETFs. 

But the same thing can happen to any inverse ETF, and that’s just not acceptable. 

A Better Way to Profit When the Market Falls

Let me ask you a question: Do you think that, at some point in the next few years, investors will be more scared than they are right here and now?

If so, I have a potentially huge money maker for you to add to your watch list. This trading vehicle will be a game changer if you don’t already know about it.

It’s an exchange-traded note (ETN) that moves up when investors are afraid, and comes down when they are complacent. And, best of all, you don’t have to worry about it going to zero. It typically spikes and then trades flat again like an EKG reading. 

It’s the Barclays iPath S&P 500 VIX Short-Term Futures ETN (VXX).

VXX attempts to track the movement of the CBOE Volatility index (VIX), which is a popular measure of the implied volatility of the S&P 500 Index (SPX).

If you don’t already know, the VIX is known as the “fear index”. It represents one measure of the market’s expectation of volatility over the next 30-day period by tracking the price of out-of-the-money options on the S&P 500.

Options get more expensive when people become fearful. They get cheaper when people become more complacent. People buy options to reduce risk, and that’s why this trades the way it does. It’s like insurance rates going up when the insurance company thinks there is a bigger risk of something. 

For example, if XYZ stock is at $10 a share, and people don’t think that XYZ stock will have much volatility in the near future, any given (hypothetical) XYZ option may be trading at $2.

But, if everything else were exactly the same (same time left before expiration, same strike price, XYZ stock still being at $10) except that there was a big story surrounding XYZ stock (such as a pending FDA approval on a major drug that could send the stock flying), the same exact option may be trading at $4.10 (instead of $2) because people are much more interested in playing the options to take a bet on XYZ’s direction.

The premium of options on the S&P 500 won’t go to zero. VIX is not a company, it’s an index. It can’t go out of business. And VXX tracks the VIX.   

Take a look at the three-year chart of the VIX below. I highlighted the time period of the 2008 crash (September 2008 – March 2009), and while you’d be happy to own VXX if the market crashed like that again, I don’t want you to expect to see that again for a long time.

VIX Chart

Below is a chart of the VIX dating back to 1990. You might notice that, even though the stock market was advancing fast in the mid-to-late 90s, the overall movement in the VIX was also up. This was because options contracts went up in price as investors speculated on stocks in addition to using them as a hedge for safety. 

You should also look at the period when the market came off the 2002-2003 bottom and rallied. The VIX declined to extremely low levels (touching 10!) as the market advanced and investors became complacent. 

But the key is the fact that it has nice spikes that you are now able to trade by using this ETN.

VIX Chart

Therefore, when the VIX is down and fear is low, it’s a great time to get in. It makes a great trade, and it makes a great long-term piggy bank that you can make deposits in a little bit at a time when investors seem to think nothing can go wrong. 

Look at the chart below of the S&P 500. We have come a long way in a short time. I can’t give you the exact timing on this, but you should consider making it part of your arsenal.

SPX Chart

Sure, you can buy it and see the market move higher and higher, and VXX would trade lower and lower as fear declined. You can be in the ETN and watch it lose value as the bull market continues higher. But, at some point, fear will always come back into the market. That’s one thing you can count on. Therefore, you can count on VXX spiking at some point.

So I’ll ask you again: Do you believe that, at some point in the next few years, investors will be more fearful than they are today?

Tell us what you think here.

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Article printed from InvestorPlace Media, https://investorplace.com/2010/05/vix-etn-foolproof-way-to-short-the-market/.

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