Laugh in the Face of Volatility with VXX

Never fear...the VXX is here!

   

Stocks are in tumult. Down huge on Monday, up big on Tuesday, and down big again on Wednesday. Gold, silver and other commodities are in freefall, and exogenous events such as the bombing in Boston and ricin-laced mail to Senators and President Obama have got Wall Street flustered. While most investors I know are cowering with fright, I know one group of traders who are laughing in the face of all of this volatility—and they are the ones who are long the VIX.

The VIX, as you likely know, is Wall Street’s “fear gauge.” More specifically, it measures the market’s expectation of volatility. In fact, the VIX is constructed using the implied volatilities of a wide range of S&P 500 Index options. This volatility is calculated from both calls and puts.

Generally, when investors are scared, the VIX soars and stocks move lower. Well, that’s certainly what’s happened of late, so it’s no surprise that on Wednesday, the VIX went parabolic, spiking more than 28% from Tuesday’s close at its highest reading, and finishing the day 18% higher than the previous close. The huge move in the VIX, formally known as the Chicago Board Options Exchange (CBOE) Volatility Index, was the biggest gain for the index in nearly two months.

For traders, getting long the VIX is easy, and you don’t even have to have an options account. My preferred way to play the fear trade is with the iPath S&P 500 VIX Short-Term Futures ETN (NYSE:VXX). This exchange-traded note allows you to bet that the volatility in stocks will continue, and that stocks will likely nosedive for the next 30 days (the future time frame the VIX measures). VXX was up 11.5% in Wednesday trade, and midway through Thursday trade the fund is up 3.7%.

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The chart here of VXX shows the major decline in the VIX for most of the last 12 months. As we faced the uncertainty of a government shutdown in the final weeks of the year, the VIX spiked, but for the most part there’s been a real lack of fear in the markets. In fact, I recall an article in February in The Wall Street Journal titled “Investors Finally Shed Fears,” which highlighted the demise of the VIX.

Well, there’s been no demise in this metric of late, and given that investors are likely to continue to worry about slowing global economic growth in places such as China and Europe; still anemic unemployment here at home; a deflationary commodities meltdown, an overbought stock market and tepid Q1 earnings, I think the VXX trade is poised to keep bringing profits.

I say buy VXX at the market for a potential 10-15% gain over the next 30 days. Be careful, however, as the mix moves very fast in both directions. That means you need to be sure and set a firm stop-loss in to protect your downside. And remember, VXX is not investment vehicles to hold for the long term, or even for more than a couple of months at most, as fear is a fickle handmaiden that you don’t want to dance with too long.

 

At the time of publication, Jim Woods did not hold a position in any of the stocks mentioned here.


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