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

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What a difference a few days make. On Dec. 12, the S&P 500 Volatility Index (VIX) had just risen about 80% in a short span while the underlying S&P 500 itself was down around 3%. The differential between a move in the broad market and in the VIX is typically only around 8 to 1, and yet we were staring right then at a bizarre moment in time when institutional investors had literally bought 20x more insurance against a market decline than they really needed.

There are very few corners of the market where you can see well-intentioned, smart managers act against their own economic interest in such a persistent fashion. Normally, such large anomalies are arbitraged away by the market very quickly. Yet this aberration persists week after week. I suppose we should not call it to their attention, because it sure works for opportunistic traders like me and my subscribers.

You would think that ultimately fund managers would get a clue and realize that their extreme swings of panic — reaching to buy puts on the S&P 500 in such vast quantities and at light speed every time the tape turns red for a few days — are costing their own customers billions of dollars every month in what amounts to unneeded insurance premiums. But they keep doing it; go figure.

The interesting thing about the most recent bout of panic at the Wall Street disco is that the ratio seems to have reasserted itself: The S&P 500 is up 3% and the VIX is down 20%, which is around a 7:1 ratio.

Since the relationship got so out of whack before, it would make sense for the ratio to get extended in the opposite direction this week; now that December options expiration has completed, I expect cooler heads to prevail. You may have noticed that the iPath S&P 500 VIX Short Term Futures TM ETN (VXX) has not yet collapsed the way it would seem that it should — considering the decline of the underlying VIX — but it most likely will before too much longer. When it does, you will be well-positioned to profit via the following trade in VXX puts.

Buy the VXX Jan. 17th $28 puts at current prices (around $1.50) for target $2.15. The option’s ticker is VXX150117P00028000; note that it is the January monthly option expiring on Saturday, Jan. 17, although some brokers may list the expiration as Friday, Jan. 16.

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.


Article printed from InvestorPlace Media, https://investorplace.com/2014/12/trade-day-ipath-vix-short-term-futures-etn-vxx-3/.

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