The VIX Is a Trader’s Best Friend Right Now (VXX)

Advertisement

The volatility beast has awoken, delivering the worst start for equities to the year … like, ever.

That’s a doozy of a stat and has fear running rampant on Wall Street. And therein lies opportunity. The oft-watched volatility gauge, the CBOE Volatility Index (VIX), is in lift-off mode, suggesting sharp swings may be the norm for a spell. At 25, the VIX is pricing in average daily moves of roughly 1.5% for the S&P 500. Given the severity of the sell-off in stocks I’m actually somewhat surprised the VIX hasn’t risen more.

Nonetheless, the oversold conditions in stocks are driving the VIX and it’s related exchange traded products into overbought territory. The iPath S&P 500 VIX Short Term Futures TM ETN (VXX), for example, has lifted 25% since pivoting higher in late December. Tactical traders often use spikes in the VIX to signal short-term buying opportunities.

The rationale goes as follows: Stock prices bottom when fear is pervasive and VIX spikes are one of the easiest ways to spot when investors are in panic mode.

VIX
Click to Enlarge
Source: OptionsAnalytix

It’s never obvious when the VIX (or VXX for that matter) will peak, but there are a few popular tools used by chartists on the VIX to determine when a peak in fear is likely.

Check out the accompanying chart. Take note of how a spike above the upper Bollinger band often signals a short-term high in the VIX. The only times that fading the VIX — or its related ETF, VXX — is not a profitable endeavor is if stocks go into full-fledged meltdown mode.

A Pair of Volatility Bets

At this juncture, traders can play VXX in either direction. Which you choose depends on your outlook. If you’re willing to bet at least a short-term bounce is in the cards for stocks, short VXX in some fashion. If you think a meltdown is imminent, go long VXX as it will undoubtedly soar amid a continuing crash in stock prices.

VXX bears can buy the Feb $25/$20 put spread for $2.90. The max risk is limited to the initial $2.90 debit and will be lost if VXX sits above $25 at expiration. The max reward is limited to $2.10 and will be captured if VXX falls back below $20 by expiration.

VXX bulls can sell the Feb $20/$17 put spread for 80 cents. The max reward is limited to the initial 80 cents and will be pocketed if VXX can remain above $20. The max loss is $2.20 and will be forfeited if VXX sits below $17 at expiration.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

More From InvestorPlace

For a free trial to the best trading community on the planet and Tyler’s current home, click here!


Article printed from InvestorPlace Media, https://investorplace.com/2016/01/vix-vxx-volatility-best-friend/.

©2024 InvestorPlace Media, LLC