Trade of the Day: iPath Short-Term VIX (VXX)

by Jon Markman | March 17, 2014 9:38 am

Trade of the Day: iPath Short-Term VIX (VXX)

The stock market finished just off its lows on Friday after a couple of intra-day buying flurries were squashed unceremoniously. Utilities and energy pipelines have been the exception, moving higher on a combination of safe haven inflows and a response by yield-hungry investors to the drop in bond yields. But for all but gold miners and utes, it was the single worst week for equities in nine months as investors grew increasingly concerned over economic data out of Japan and China as well as the simmering Cold War-era standoff over the fate of Crimea.

While stocks are down, the drop hasn’t been catastrophic. Much of the worst action thus far has been in ancillary areas such as copper, crude oil and Asian markets. And much of this, in turn, has been driven by volatility in currencies. U.S. equities have skidded to be sure but are not beaten up, as the impulse to sell hard has not materialized.

However, the mysterious disappearance of a Malaysian Airlines jetliner that (up until now) has been considered the safest plane ever built has not helped matters at all, as it reminds people of one of the elements of modern life that we don’t like to confront: That there are unknown, unseen, unfathomed risks lurking amid the shadows of the technology that surrounds us.

The last time we saw the latter was in April 2010, when a BP (BP[1]) oil well blew up in the Caribbean, sending incredible quantities of oil gushing into the ocean. Minor mistakes happen on oil rigs all the time, but it was the inability of the best companies using best practices to understand what had happened and how to fix it that wore on the public’s collective conscience.

It may have been a coincidence, but history shows that the worst stock slide of the current bull cycle began with that hole blown in mass confidence and continued for the next six months as the market ultimately hit rock bottom after a 19.5% decline from the April 2010 high to the ensuing autumn. To be sure, there were numerous other real issues, such as Congress’ battle with the White House over the fiscal debt ceiling, the downgrade of U.S. Treasurys and the eurozone credit crisis — but it all started with an event that made investors and the public alike lose a measure of mental security about intangibles.

I am not saying that the disappearance of the Malaysian jetliner is directly responsible for the 20% rise of the S&P 500 Volatility Index (VIX[2]) in the past five days, or the 1.5% loss in the S&P 500. They each have much more direct causes like the Russian and Chinese troubles, and the confessions by U.S. companies that first-quarter earnings may be a lot more negatively impacted by snowstorms than they expected. But I am saying that when a lot of nagging concerns occur at the same time, they can magnify each other’s individual effect to be greater than they might otherwise have been.

Keep in mind that situations in which market volatility becomes wildly inflated, then settles back down, have happened dozens of times in the last 15 months. Taking past as prologue, you can expect the current fear and anxiety to broadly abate, sending the VIX tumbling and the S&P 500 rising back toward recent highs.

So for a contrarian trade on the present volatility spike, I recommend buying put options on the iPath S&P 500 VIX Short-Term Futures ETN (VXX[3]), an exchange-traded note based on the VIX. Let’s go out to May; that way, we’ll have the opportunity to earn more premium, as well as give ourselves plenty of time for the expected market move to occur.

Buy the VXX May $46 puts at $4.95 limit, good till canceled. Make sure to purchase the monthly option expiring on Saturday, May 17. When filled, set up to sell your position at $9.40 limit, good till canceled, so as to grab a 90% profit on the next big slide in volatility.

Jon Markman operates the investment firm Markman Capital Insights. He also offers a daily trading advisory service, Trader’s Advantage, and CounterPoint Options, a service that helps individual traders make steady, consistent profits with volatility-related instruments.

Follow Jon Markman at Google+.

Endnotes:
  1. BP: http://studio-5.financialcontent.com/investplace/quote?Symbol=BP
  2. VIX: http://studio-5.financialcontent.com/investplace/quote?Symbol=VIX
  3. VXX: http://studio-5.financialcontent.com/investplace/quote?Symbol=VXX

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