Like a thief in the night, volatility has returned. The CBOE Volatility Index (VIX) is up 74% in the past week, bringing renewed strength to volatility-based funds the land over. Count the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX) and the ProShares Trust Ultra VIX Short Term Futures ETF (NYSEARCA:UVXY) among the big winners.
Despite their obnoxiously lengthy names, both VXX and UVXY do a commendable job in tracking the VIX in the short run.
The long run? Not so much. Make no mistake: VXX and UVXY are short-term trading vehicles and nothing more.
So why the sudden volatility surge? The blame lies in part on the pullback seizing equities in recent days. The S&P 500 is down 2% over the past week, a mild dip if there ever was one. And certainly not the type of selling that justifies a scorching VIX rip.
For the extra oomph behind the fear gauge’s sudden awakening, traders can thank the upcoming “Brexit” vote. And, what the heck, throw the looming Fed meeting in as yet another, albeit smaller, hobgoblin.
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Traders looking for proof that the “Brexit” has the investing classes’ knickers in a twist need merely look at the implied volatility spike striking the iShares MSCI Germany Index Fund (ETF) (NYSEARCA:EWG) and the Guggenheim CurrencyShares Euro Trust (NYSEARCA:FXE). Option premiums are swelling in anticipation of the vote’s aftermath.
Rather than fearing volatility’s return, traders should embrace it. The premium expansion means option enthusiasts are being amply rewarded for selling their wares.
One of the simplest ways to play volatility is via the VXX. The current spike, like all its predecessors, was born to die. Sadly (or gladly, depending on your perspective), it’s not a question of if, but when. Opportunists should be on the lookout for a pivot high in the coming days to signal the time is ripe for a bear play.
The VXX Trade
If you think the current stock dip gets bought in the coming days and the looming Brexit vote fails to topple equity prices, consider entering September put spreads on VXX. Basically, if stocks recover, volatility will drop, taking VXX down with it.
When the turn comes, I suggest buying one strike in-the-money and selling a couple strikes out-of-the-money. For example, with VXX trading at $16.90, I would buy the Sep $17/$14 put spread.
If VXX continues climbing to $18 or $19, continue switching up the strikes to a Sep $18/$15 or $19/$16 spread when you pull the trigger. The risk will be limited to the initial debit.
By using September options, you give the VIX and VXX ample time to subside following all the Brexit hullabaloo.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
