Traders: Profit From Volatility With These VXX Options

Advertisement

This week greeted stock traders with a double dose of overnight down gaps as February proves a continuation of January’s volatility.

As of Tuesday’s opening price, the S&P 500 was already down 5% on the month. On the heels of the downdraft, the CBOE Volatility Index (VIX) is once again closing in on the 30 level while volatility products like iPath SP 500 VIX Short Term Fut ETN (VXX) are flying.

Once the VIX reaches these levels we often see a snapback in equity prices in short order. Spikes in the VIX — the likes of which we’re experiencing now — indicate extreme levels of fear rushing into the marketplace. And this signal is quite useful for the contrarians among us, as this magnitude of panic is typically seen near market bottoms.

While buying and selling the VIX index directly is impossible, there is a growing stable of tradeable products based on the popular fear index.

Perhaps the most popular is the aforementioned VXX, which is designed to track short-term VIX futures. In the short run, its behavior closely parallels the VIX Index.

VXX
Click to Enlarge
Source: OptionsAnalytix

As such, VXX has ripped higher this week and now sits in overbought territory. If equities can stage a comeback from their recent downdraft, volatility should subside bringing lower prices to VXX.

Traders willing to wager on such an eventuality have a number of attractive plays to consider.

The VXX Trade

One cheap, not to mention limited, risk avenue for positioning to profit from lowered volatility over the coming months is to buy VXX put spreads. Often referred to as a bear put spread, this straightforward strategy allows you to score big returns if VXX can fall back from its lofty heights.

Buy the April $27 put and sell the April $23 put for a net debit around $2. The max risk is limited to the initial $2 and will be forfeited if VXX sits above $27 at April expiration. The max reward is limited to the distance between strikes minus the net debit, or $2, and will be captured if VXX can fall below $23 by expiration.

By risking $2 to capture $2, the spread offers the potential to double your money. And by using April options we’re giving VXX plenty of time to settle down.

At the time of this writing Tyler Craig had no positions 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/2016/02/vxx-vix-options/.

©2024 InvestorPlace Media, LLC