Don’t be fooled — nothing great has actually happened in Europe, so if you’re betting the skies will stay clear now that a bailout has been announced, you might want to reconsider your position.
Remember on Sept. 19, 2008, when the SEC tried to deliver a financial punch in the face to “the evil” short sellers in the United States by banning short selling in 799 bank stocks? The market lost over 25% in two weeks, 35% in two months, and 45% in six months!
The European governments are simply manipulating their markets higher, and they are doing so with tax dollars! Markets didn’t rally in celebration of a solution. Instead, the eurozone is simply stepping in front of a big short position and buying tons of Greek bonds (and they’re willing to do the same for whoever else needs help in that neighborhood). It’s causing short sellers, who realize there is new demand keeping prices from falling any further, to buy back their short positions, thereby causing a short squeeze.
For perspective, consider this the opposite of what happened in the winter of 2008-2009. Hedge funds, whose clients requested cash, were forced to dump tons of stock in great companies that they didn’t really want to sell. That pushed the prices of those great companies even lower.
Well, in the eurozone, the shorts don’t think Greek bonds should advance, nor should the euro, but they’re forced to exit their bearish positions … pushing prices higher. But nothing has really changed in the last few days.
Even the United States (the world’s largest economy, which has the largest quota to pay to the IMF) has its tax dollars being used by European governments to bail out Greece and company.
So let’s book some bearish profits on the next downfall, just like we did from September to November of 2008.
Don’t get me wrong, I’m not saying the same exact thing will definitely happen all over again, but it’s certainly very possible. And if it happens, you want to profit from it. But at the same time, keep in mind that the U.S. government had been manipulating its equity market higher for over a year quite successfully. Can the eurozone do the same? I doubt it.
Let’s remember one more thing: The euro-mess just happens to be the hot story of late. It’s not the only thing that can smack this market down. Whether the eurozone bailout is a magical silver bullet or not, the fact is that the U.S. economy is far from perfect right now. And, now that we’ve seen a sharp jolt in the market, the bears will likely start to smell the blood.
Last week, I talked about using an ETN to play a sharp decline in the market, or an increase in the fear level, the Barclays iPath S&P 500 VIX Short-Term Futures ETN (NYSE: VXX). Heck, I mentioned it would spike if the market simply stopped being so darn overly complacent.
Today I’ll tell you I don’t think you’ve missed the boat!
When the market sold off Thursday (May 6), VXX rallied from the level of about $22 on Tuesday (May 4) to over $31 intraday, and closed at $26.12. Remember, it spikes when complacency turns into fear. The next time it spikes, I want you to be in it.
It’s not like you only had a 20-minute window on Thursday’s quick intraday sell-off of 1,000 points before the market reversed back up. The VXX also rallied over $31 the following day (Friday, May 7) and even closed at a much higher price ($29.25).
My point is that you shouldn’t make the common mistake of thinking this ONLY moves based on an inverse relationship to market movements. In other words, focus on the fact that it pops when people are FEARFUL.
Investors can experience increased fear even when markets are recovering and moving higher, although that wasn’t the case this time. Just train yourself to think of this properly, and you’ll be cranking out “misery profits” again and again.
Now, VXX doesn’t track the movement in the CBOE Volatility Index (VIX) exactly. In fact, it tracks the S&P 500 VIX Short-Term Futures Total Return Index. But the bottom line is it pops when volatility spikes (when fear spikes).
And while it may not track the VIX exactly (may be up by less or may even be down by more), it makes sense to trade this, as opposed to VIX options, which might barely move up or even move down when the VIX spikes. I don’t get hung up on whether it tracks the index perfectly — or even well — when spikes in volatility mean 40% – 60% spikes in VXX.
Your Next Opportunity to Profit With VXX
Let’s look at trading the VXX in light of the recent $1 trillion eurozone bailout, announced on Sunday, and how VXX will be giving you another opportunity to capitalize on stupidity — er, I mean irrational exuberance. (I always admired how Greenspan masterfully pointed out global stupidity with such class.)
So far the eurozone has been the gang who couldn’t shoot straight. I’ve lost count of how many bull prodding “solutions” and proposed “bailouts” they’ve announced, but every time, soon after, the bullish sentiment fizzles out fast.
Sure, maybe a bunch of broke countries will be able to lend each other money. And, heck, maybe it does make sense for the European Central Bank to literally accept, as collateral for loans, junk bonds that have seen their default insurance (CDS) go from $5,000 to over $900,000 to insure $10 million of Greek debt for a five-year period. (And that’s up from $250,000 in January of this year.)
But to me, that just doesn’t sound like a rosy picture.
Quote from The Wall Street Journal: “The ECB said its decision to buy bonds was justified by governments’ agreement to greater fiscal discipline, abandoning resistance to asset purchases just days after ECB President Jean-Claude Trichet said the idea had not even been discussed.”
These guys seem like they are pulling all night benders (like Paulson, Bernanke, Geithner and the giant bank heads did in 2008) and coming to work, weathered, making decisions while they’re about as focused as you would be after that kind of stress.
I don’t know, folks. This seems eerily similar to September 2008, before the crash, when I told people not to buy into the U.S. bailout sentiment.
On Sept. 19, 2008, the SEC temporarily banned short selling on 799 bank stocks and stocks rallied (were technically forced, or manipulated higher). On Sept. 23, the plan was presented by Henry Paulson and Ben Bernanke to the Senate Banking Committee (who rejected it as unacceptable).
Well, in Greece, on April 28, 2010, the country’s securities regulator banned short selling on the Athens stock exchange. Then, on Sunday, we hear about the $1 trillion package (about 750 billion euros). Just like our government wasn’t actually in agreement on the details, we just may see the same thing from the eurozone.
By the way, the package consists of 440 billion euros in guarantees from euro area states, which is something we are hearing little detail about. The eurozone has been revising and adding to their bailout plans much like the wrangling that went on among members of Congress over the terms and scope of the U.S. bailout. Aren’t most of these countries broke?
I have a feeling it’s not too late to take advantage of the insanity. I would be very careful about playing the bull side here. Because it may be just that — the “bull” side.
VXX may not track the VIX perfectly, and it may not even track the S&P 500 VIX Short-Term Futures Total Return Index perfectly. But it DID jump about 45% within about 48 hours after I wrote about it. So I really don’t care how perfectly it tracks. (VIX options are far from tracking perfectly, and can be dangerous here).
Hey, I’ll be the first one to play both sides of the market. I have both bullish and bearish positions on right now. Soon I’ll have a more bearish model portfolio, and as the market evolves, I will too. Financial markets are a dangerous place to “stick to your guns”.
Stay safe, stay hedged, limit your downsides, and don’t believe the hype.
