Both stocks and volatility behaved themselves last week, as the S&P 500 gently glided 0.9% higher and volatility ebbed 9.3% lower.
If the market rose and the S&P 500 Volatility Index (VIX) fell by that much every week for an entire year, there would be celebration in the streets, fireworks, a national holiday, and cats and dogs would embrace.
But it doesn’t actually work that way, and normally you can bet that when it appears that it’s all quiet on the western front, there is sure to be trouble creeping up stealthily in the east, south and north.
After months of high-volatility events ranging from invasions of sovereign nations by un-uniformed Russian militia, chemical weapons in Syria, missing commercial airliners in Malaysia, and riots in Rio, it’s actually kind of nice to take a break from worrying every morning when you wake up whether the Dow is going to be up 200 points or down 200 points for reasons you could never have imagined when you went to bed.
One reason for the decline in volatility is that (at least in the United States) bulls and bears have had a chance to duke out their differences and for the moment have fought to a draw. In the case of the U.S. economy, the bears’ case was that unusually harsh winter weather had killed economic activity in the first quarter and companies would be slow to recover in April and beyond.
Out of this hypothesis, they built a case that job growth would continue to be anemic in the second quarter and that companies would report such weak Q1 sales that they would be obligated to bring down Q2 and Q3 estimates as well.
But, of course, it hasn’t worked out that way. On Friday we learned that U.S. non-farm payrolls jumped by 288,000 jobs in April, and the unemployment rate plunged to a 52-month low of 6.3%. The consensus forecast was for an increase of 218,000 jobs. The severe winter weather may have torched activity and employment in January and February, but employers stepped up their pace after that and made up for lost time.
But don’t let the bullish headlines lull you into a false sense of security that volatility will continue to fall. The VIX is a funny beast and does not always move in the ways that the conventional wisdom expects.
The famed “fear index” only behaves in sync with what the crowd expects often enough to lull everyone into a cloud of complacency. And then the VIX will suddenly reverse course and march to its own drummer, leaving the crowd baffled. With that in mind, I recommend that you take advantage of this low point in the VIX to trade the call options while they are cheap.
Buy the VIX June $13 calls at $2.70 limit, good till canceled. When filled, set up to sell the entire position at $3.10, good till canceled. That way, you’d be making a quick 14.8% gain when other traders are scrambling to cover their positions on the wrong side of 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.
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