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What Is the VIX? And How Can I Trade It?
How can I make money trading the VIX? That’s one of the most popular questions we get from aspiring traders. And they usually don’t like the answer — because you can’t trade the VIX. The VIX — better known as the Chicago Board Options Exchange Volatility Index — is not a security, and thus the number you see on your screen is not a price. It’s actually a trading indicator. The VIX uses prices of various S&P 500 options with expirations between 23 and 37 days to measure traders’ expectations of volatility. The VIX helps us measure sentiment by telling us how much traders are willing to pay for these options. Typically, the VIX rises when traders are worried about downside risk. Why? Because when traders are worried about downside risk, they’ll pay higher prices for downside protection through options. Let’s take a look at a 10-year monthly chart of the S&P 500 (bar chart) against the VIX (purple line): The chart shows that the VIX had major spikes during the: A) Financial Crisis B) Flash Crash C) Euro Sovereign Debt Crisis D) August 2015 Minicrash This illustrates how the VIX rises when traders are scared and markets are coming under pressure. Why? Again, because traders were willing to pay up big for downside protection through S&P 500 options. The same dynamic plays out on shorter time frames. As you can see in this 20-day hourly chart, when the S&P 500 (bars) rises, the VIX (purple line) falls: And vice versa. What You Can Trade We told you before that you can’t trade the VIX directly, since it is an indicator. However, there are many derivatives of the VIX that can be traded. But before we proceed further, you must understand that virtually all VIX-related instruments can be tricky to deal with. And we urge you to read the prospectus and understand the pricing mechanics of any VIX-related instrument you trade. VIX Options and Futures The CBOE has created VIX futures and options. VIX futures trade nearly 24 hours, 5 days a week. And VIX options can be traded just as easily as a standard equity option. However, keep in mind that VIX options typically expire on Wednesday, and VIX options contracts are based on the price of VIX futures, not the VIX itself. VIX ETN’s There are many VIX-derived exchange traded products, the most popular of which is the iPath S&P 500 VIX ST Futures ETN (VXX). The VXX aims to deliver the return of the S&P 500 VIX Short-Term Futures Index. Many traders also follow the Credit VelocityShares Daily 2x VIX ST ETN (TVIX), which aims to deliver twice the daily return of the S&P 500 VIX Short-Term Futures Index. VIX ETN’s can be bought and sold like stocks. However, they only appropriate for short-term trading since they don’t track the VIX — they track VIX futures, which tend to naturally fall over time. Here’s a direct excerpt from the VXX prospectus: The index underlying your ETNs is based upon holding a rolling long position in futures on the VIX Index. These futures will not necessarily track the performance of the VIX Index. And for technical reasons related to the VIX futures term structure, they tend to decline over time: On the flip side, shorting these instruments over the long run is not easy because of margin requirements and other issues. Plain Old SPY Options The easiest way to trade changes in the VIX may be to just trade SPY options. They’re very liquid and easy to trade with none of the complex mechanics involved with VIX futures, options, and ETN’s. For example, if you think the VIX is set to increase sharply, rather than messing with VIX products, you could simply buy SPY put options. Why? Because a higher VIX means higher put options prices. Remember, the VIX is a measure of implied volatility on S&P 500 options. And all things being equal, when implied volatility goes up, options prices go up. (click here for a primer on implied volatility) And on the flip side, to speculate on a falling VIX, one could simply buy SPY call options, since a falling VIX is typically associated with rising stock prices. Sure, the VIX products are sexier and more exciting, but for newcomers to trading, simpler is often better.
Continue Reading -->The VIX Has Bottomed… and 4 Other Thoughts on Today’s market
Want to Start Earning Bigger, More Consistent Profits? Dave Green can show you how! 1) Return of Volatility? Volatility may finally be returning. As you can see in this chart, the VIX hit a bottom last week at 11.02. It’s now above 12 and I think it moves much, much higher from here. (full disclosure: I am long VIX calls) We just went through 26 straight days without a 1% move in the SPX. Volatility is mean-reverting. You never know exactly when the pendulum swings back, but I believe we are eyeing the seeds of it. For example… 2) Russell Down? The Russell 2000 is underperforming today, which is a reversal of the recent trend. This could be a sign that traders are growing a little wary and taking some profits off the table. Right now, the Russell is at the lows of the day. If it makes even lower lows, the bulls will get more nervous. 3) Biotech! The bios are underperforming a little bit today, but like the Russell, traders will get nervous if we see a real breakdown here. For the past couple of years, biotech has been ground zero for speculative money, and when it breaks higher, the bulls tend to feel pretty good. And of course, the flipside is equally true. Bulls get nervous when the bios give up. IBB needs to hold $290ish. 4) Apple & Berkshire Apple’s (AAPL) mega rally off $91.50 was ignited by Berkshire Hathaway’s buy of the stock. Today, it’s getting a little pop on news that Berkshire increased its stake. It would be funny if Warren Buffett marked the bottom and the top. 5) Tomorrow Is a BIG Day Tomorrow we’ve got crude oil inventories and the FOMC Minute, both of which could set off some fireworks. Traders are once again completely confused over the Fed’s direction, and maybe we get some clues as to whether a September rate hike is on the table as some folks have intimated. And with the marketing teetering back and forth, maybe traders get worried if oil breaks down. 6) Twilio! (BONUS ROUND!) Twilio (TWLO) is the current poster child for momentum trader wackiness. It’s still going strong even though some others like ACIA and FN are falling off. If TWLO follows suit, it could be another sign of profit-takers cashing in. By the way, a lot of traders are talking about TWLO as if it’s a sure-thing short, but I would not touch it on the short side. P.S. Have you signed up for Dave Green’s FREE trading webinar yet?
Continue Reading -->The Morning Hammer: Another Day, Another Yawn
On Thursday, my buddy Dave Green is hosting a FREE trading webinar. Click here to check it out! Yesterday after the close, the American Petroleum Institute reported a 2.1 million barrel increase in crude oil inventories, which is pushing oil prices down a bit overnight. We have EIA inventories coming at 10:30 a.m. ET, with economists expecting a -1.5% million barrel drop. They also expect drops in Cushing, OK inventories and gasoline inventories. We also have JOLTS Job Openings at 10:00 a.m. The People’s Bank of China said it will promote greater international use of the yuan, though the bank didn’t promote much detail. The dollar is down as traders believe the Fed will be less hawkish… ALLEGEDLY. That’s the picture some outlets are painting, though I’m not buying it. Fed Funds futures are now pricing in a 45% chance of a December rate hike, down from 47% last week. That’s not much considering this number was 9% on June 27, just after the Brexit. The reality is that Fed expectations can turn on a dime. A few more hot economic data points and hawkish Fed head chatter, and it could go above 60-70%. And of course, it could go to 30% just as easily. Crude oil has climbed off overnight lows and that’s pushed SPX futures into the green. So we’re back in the waiting game as the August doldrums continue. Yesterday morning, I went long VIX calls, which means I’m effectively short the market in the near-term. (I also have long-term equity/HY exposure through AAPL, BGR, KYN, PHK, VIG, and UTF, none of which I would buy now, except for closed-end fund dividend reinvestments) But for now, it looks like Mr. Market is quite happy to stay in this go-nowhere range. Crude oil was saved from breaking $42, though the 10:30 a.m. inventory numbers could change that. Also keep your eyes on the other usual suspects — the Russell 2000, biotech (IBB), and high-yield (HYG). The bulls have done a great job of defending these key areas, so see if they can keep it it up.
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