The ProShares Trust Ultra VIX Short Term Futures ETF (NYSEARCA:UVXY) is a double-leveraged fund that looks to capture two times the daily performance of the S&P 500 VIX Short Term Futures Index. It’s important to note that it’s two times daily performance (so longer-term performance can skew), and it’s also on the short-term futures index.
But for traders (not investors!) looking to take a very aggressive bearish stance in the markets over the next few weeks, UVXY can provide the answer in a big way.
Most people are familiar with the VIX, otherwise known as the CBOE Volatility Index. It looks to measure the options market expectation of future volatility over the coming 30 days. It is also called the Fear Index, with low levels of VIX displaying little angst and high levels of VIX exhibiting heightened anxiety.
Currently, the VIX is trading near multiyear lows, hovering right above the $11 support level. While VIX can grind sideways for extended periods, it is usually a reliable indication of a stock market that has become overly complacent may be ripe for a sharp and sudden drop.
The last time the VIX was at comparable levels for this length of time was back in early September 2016. Shortly after that, volatility spiked dramatically. UVXY spiked even more dramatically, rising 50% in just four days! This highlights the effect leverage can have on the UVXY during meaningful moves higher in VIX.
While selling volatility has been a profitable endeavor over the past several years, selling volatility at current levels has proven to be not so profitable. Speculative short interest is fast approaching similar levels that preceded the last two meaningful moves higher in VIX.
With stocks at historically rich multiples and interest rates no longer proving a tailwind, it won’t take much of a shock to send VIX (and therefore UVXY) dramatically higher.
As Warren Buffett famously said, “Be fearful when others are greedy and greedy when others are fearful.” That most assuredly applies to trading volatility. So to position to profit from potential problems, I like a long call diagonal spread in UVXY.
How to Trade the UVXY
Buy UVXY Feb $30 calls and sell UVXY 27 Jan $34 calls for a $3.20 net debit.
The trade is net long 28 deltas at inception. Maximum loss is limited to $320 per spread. Ideally UVXY spikes toward $34 over the next two weeks. If not, you can sell some additional shorter-term calls after Jan. 27 against the long Feb calls to further hedge the position.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at email@example.com.
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