Trade of the Day: VelocityShares Daily Inverse VIX ETN (XIV)

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With the exception of some brief rallies this week, the market continues to sell off, and my indicators are now giving extremely bearish readings. This does not paint a bright picture of what’s to come — and, furthermore, market internals are showing that additional weakness could be in store for the major indices.

For example, at the lows on Wednesday, the benchmark S&P 500 index was down by approximately 15% from its high of 2,134.72 that was set last May. Taking a wider view of the deterioration, out of all of the stocks in the entire U.S. stock market, 76% are down more than 16% during the past 18 months. Additionally, 56% of all stocks in the market are down more than 25%.

The Russell 2000 small-caps have fared even worse. At current levels, the index has dropped approximately 22% from its high, officially entering bear-market territory. In fact, this is the worst action in the market for the first month of the year so far. These figures should come as no surprise to my readers, as I have been warning about an impending bear market recently.

Market technicians and technical traders will also point out that a number of key support levels and long-term uptrend lines have been violated to the downside on all of the major indices. Looking at a chart of the S&P, I see a “head-and-shoulders” pattern forming over the last two years, and its neckline was broken briefly at the lows this week. Another break of the neckline could lead to another leg down for the market.

How far down?

A conservative — and optimistic — downside target for the S&P 500 is 1,575, which is a support level that also marks the 2008 top. That’s a pretty big move, but it’s still not drastic. The speculative — and pessimistic — downside target is much, much lower than that.

The January barometer also suggests that right now there is a high probability that the market will trend lower for the rest of the year. It will take a Hail Mary pass to reverse that trend, and there is little evidence to suggest if or when that might occur.

Turning to commodities, which have been one of the main drivers of recent economic weakness, the price of a barrel of oil is now lower than cost of the barrel itself. I’ve mentioned before that oil-producing nations are trying to pump their way out of an international debt bubble and economic turmoil, and that has led to even lower prices.

Each oil-producing nation is trying to pay off its massive debt, and that debt is forcing them to keep pumping oil, which leads to build-ups of excess supply…but none of them are slowing down. Furthermore, U.S. officials recently lifted sanctions on Iran, From what we know, Iranian officials are aiming to increase output by 500,000 b/d immediately, and ultimately double that figure within seven months. Despite these ambitious goals, analysts remain skeptical given the amount of investment required and engineering setup involved.

Several decades ago, we had a similar situation with the price of copper. Copper-producers kept mining until they pushed its price down to $0.50 per ounce, which ended up being well below the cost of production. It kept falling because copper-producing countries had to pay off their debts. The same thing is happening now, and that’s one reason why commodities and the market keep moving lower.

Yet, I can’t emphasize enough that even during the worst bear markets, the market will experience very sharp rallies — and they usually continue for much longer than what would otherwise be sustainable. At or near the peaks of these rallies, we’ll focus on buying puts that will appreciate as the market falls back down.

I understand that bear markets are scary for many investors, but there is one irrefutable fact that should give you some comfort as a trader. Stocks fall much faster during bear markets than they rise during bull markets, which means that put options tend to generate profits more quickly. Historically, I can tell you that I tend to make more money trading in down markets than I do during uptrends.

My hope with Power Options Weekly and Maximum Options is to empower you to not only weather bear markets but to profit from them with bearish strategies. Buying put options is my preferred bearish tactic in Power Options Weekly.

However, in Maximum Options, I put my 40-plus years of trading to full use by offering my professional-grade trades by opening options spreads, shorting options, and targeting inverse ETFs in addition to buying options.

One of my favorite strategies to employ when volatility is high, as we’ve seen lately with the S&P 500 Volatility Index (VIX) spiking to 27 this week, is to buy the VelocityShares Daily Inverse VIX  ETN (XIV), and simply hold it for as long as it takes for volatility to dissipate.

In simple terms, the XIV increases in value as volatility decreases, that is, when the VIX goes down. In the chart below, you can see the inverse relationship between the two.

S&P 500

So, if you buy XIV shares when the VIX is at a relative high, you’re buying XIV low. Then, as the VIX settles back down, you can expect to see the value of XIV shares rise, at which point you can sell for a profit.

Very often, at Maximum Options, we are able to take profits on an XIV trade within a matter of days as volatility swells and contracts rapidly. But the beauty of this strategy is that even if it takes several months, it’s almost a guarantee that at some point, volatility will recede and the XIV will increase.

Even after the VIX hit historic highs of 59 on Sept. 30, 2008, it was only a matter of months before it dropped back down to the 40 level on Dec. 1, 2008. Unfortunately, the XIV wasn’t created until 2010, so there’s no way to project what gains in XIV might have been in during that period, but I can tell you that recently my Maximum Options members enjoyed a 30% profit in one day in XIV.

On Aug. 24, 2015, I recommended we buy XIV near the open. We got in at $26.10. By the afternoon, XIV had risen to the $34.00 range, which is where we exited and pocketed the gains.

I’ll be the first to tell you that it usually requires a little more patience than that, but we can typically expect about 4% to 10% in about a week with this strategy.

Therefore, my recommendation is to buy shares of XIV at current levels, and simply be patient and wait for volatility to subside.

It’s likely that we may actually see volatility spike a bit more, given how bearish things look. So, build XIV positions here and add to them if the VIX jumps to 40. At that point, buying XIV shares is the closest thing to sure money I can think of.

I always let my Maximum Options subscribers know exactly when it’s time to take profits because things move quickly. Join us so you don’t miss a single of my recommendations.

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Article printed from InvestorPlace Media, https://investorplace.com/2016/01/sp500/.

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