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At the time of this writing, the VIX is at 11.15.
And with so many talking about the death of volatility (which isn’t true) you might want to take a contrarian bet and get long the VIX.
So you open up your brokerage account, pull up the VIX, and place a buy order.
You’ll probably see this pop up:
Well that’s not good. It turns out, the VIX is a non-tradeable statistic, derived from SPX options pricing.
What do you do now?
You could trade VX futures! Let’s have a look at the current prices:
You could buy the June VX future for 12.24, but those only trade for one more week and converge on the spot VIX. If nothing happens you could see a buy of 12.24 drop all the way to 11.
Instead you could buy July VX futures… for a higher price. Because more bad stuff can happen in a month. The more time to expiration, the higher the cost. In fact, buying a July VX future at 13.50 isn’t the best deal in the world because we haven’t traded above 14 in 2 months.
So you move on to VIX options… except the underlying of VIX options isn’t the VIX, it’s the expected value of what the VIX will be in the future, as reflected in VIX options.
Maybe buying a July 12 call for 1.75 is a good bet (which I think it is)– so if the VIX pops, you’ll see a move.
Here’s the problem with that– if and when the VIX does move to the upside, the VX futures (and the corresponding gain in the options) will be dampened because much of that will have already been priced in.
If the July VX future is at 13.47 and the VIX pops up to 16, that doesn’t mean the future will pop up 5 points as well… the futures market may in fact trade at a discount to the spot VIX, which often happens during market pullbacks.
You could then look to vol ETP’s like VXX and TVIX, but those come with roll yield issues and structural inefficincies.
And so on.
The point here is not that long volatility is a bad trade– in many cases long vol is a great trade here.
But thinking you can just get long the VIX because it hit 11 is a much more complicated idea than what it seems.
There is a massive myth out there when it comes to income trades like iron condors.
The myth is that you can somehow put on these trades and collect your monthly returns while you sit on a beach with a fruity drink in your hand.
But if you try to trade that way, your losses will be a lot greater than the money you make.
Income trading is a lot more active and dynamic than you think.
Here is a recent trade we took in IWO Premium.
The Russell had the highest implied volatility in all the indexes, so it made the options the best “sell” if we thought the market was going to stay quiet.
I had one concern, that somehow the RUT would rip higher… since income trades normally start out short by way of their structure, we would be sitting at losses if the market ran higher.
To start off the trade, we picked up some RUT put butterflies but also bought some IWM calls– since IWM is 1/10th the size of RUT it makes for a great hedging device.
This got us delta neutral. If the Russell ripped higher, we’d take off the calls for a profit, and if we headed lower then we would be in the “sweet spot” of the butterfly spread.
The Russell then sprung higher to around 1140. We were losing money on the put butterflies but made up for those losses with gains in the IWM call hedge.
By putting on hedges at the beginning, it gives us a lot more wiggle room in the trade compared to a more traditional “set and forget” income trade.
From here, we closed out the IWM call buys and picked up another round of RUT butterflies.
After a pullback and a little more chop, the trade currently stands at a return on risk of 20%, when the profits from the IWM hedge are included.
We’re now in the “milking” phase, where we try and squeeze some further profits out of the trade before we exit.
Is this more complex? You bet.
But you end up with much better risk adjusted returns, and a lot fewer headaches compared to just sticking on some iron condors and wishing for the best.
If you want to learn how to make trades like this, we’re doing an Income Trading Workshop on Tuesday, May 27th. Click here to learn more.
“Oh, you trade options? I did for a while too. Made a good amount of money, but then gave it all back.”
I’ve heard that more times than I can count.
And it will continue to happen. Someone who is new in the markets gets on a winning streak because a market is trending. Soon enough they’re bragging to their coworkers about the abnormal returns they’re getting in the market, and are planning their next car purchase with the profits.
All of a sudden, something stops working. They get frustrated, go on tilt, and then wipe out their profits.
Successful financial speculation is not about what you do when you are winning, it’s about what you do when you are losing.
Financial losses are a part of trading, and can be considered an obstacle to building wealth. But through those obstacles you’ll actually find success.
This book is about looking throughout history for examples of how very successful people overcame some terrible things… and that those “obstacles” helped to define them and create their success.
Trading and investing is an iterative process. If you lose money, you need to figure out why you lose money, otherwise you’ll make the same mistakes.
Here’s an example from my trading methodology: I never sell bull put spreads on the first ugly day lower. I used to get very eager to “fade” the market once it had a nasty selloff, but I now know that volatility begets volatility and so I can wait a little longer for better trades.
Why you should read this book: by looking into the past and seeing how great people acted when they hit a brick wall, you will be able to apply some of that methodology to your trading and investing.
Follow the Process. Coach Nick Saban teaches his players to not focus on the next game, the SEC title, or the national championship. Just focus on the next play.
How this applies: no matter if your previous trade was a win or a loss, no matter how badly you want to retire early, you can only focus on the trade that is in front of you.
Use the Obstacle As Opportunity. The German Blitzkrieg was a tactic that involved very fast troop and armor movement into a territory, keeping the allies on their heels. Eisenhower used that to their advantage by allowing the first column through and then attacking at the sides. This counter helped him to win the battle of the Bulge.
How this applies: algorithmic and high frequency traders can devestate your short term trading, because they will run your stops and front run your trades. Counter that by recognizing the “obvious” stop loss areas and buy the flush and reversal instead of the support level.
Love Everything That Happens. In the middle of growing his business, Thomas Edison’s factory caught on fire. Instead of freaking out, he invited everyone out to watch it burn as it would be a spectacular sight. He then rebuilt it from the ground up and made a ton of money.
How this applies: your outlook and happiness need to be independent of the outcome in your trades. Viewing losses as an opportunity to get better will help your growth more than anything else.
Pick it up on the Kindle [update: if you pick it up today (May 15th) it's only 4 bucks]
Here’s the deal. I’ve got an extra copy signed by Ryan that I’m giving away to one lucky reader.
All you have to do is join the IWO Facebook Page.
On Friday, May 23rd we will have a random drawing and one of our facebook fans will win the copy.
Unlike many other times in this bull market, not all stocks are running on the same high-correlation macro conveyor belt.
It truly now is a market of stocks, with certain sectors holding up fine and others getting shmammered.
This is most likely due to too many people chasing the same things that worked in 2013, and using way too much leverage to do it.
What are we left with?
The S&P and Dow hitting new all time highs, while the Nasdaq is struggling and the Russell 2k (small caps) looks like dog food.
If you’re an investor that needs protection, it means your probably in stocks that are in the indexes that are underperforming.
So why would you buy SPX puts?
Why would you buy VIX calls?
Instead you would be picking up puts in the RUT and NDX, and maybe (if liquidity allows) buying some calls in the RVX, which is the volatility index for the Russell.
This all makes sense. It’s quite obvious once you step through the logic (no vulcan).
So why are so many still using the VIX as a reference point?
Why are so many saying “there is no fear” in this market when in fact their clearly is?
Let’s take a look at a chart of the RVX:
Unlike the VIX which is near 6 month lows, there has been a steady and persistent bid in protection in smallcap stocks.
And it makes perfect sense. Fear exists where fear is warranted.
You’re going to see higher premiums paid for hurricane insurance in Louisiana than Oklahoma, and you’re going to see higher premiums paid for a market down nearly 10% than one hitting all time highs.
It’s not that fear is disappearing, or that investors are super complacent.
It’s that fear is in the right place, and if anything investors are being smart about where they are buying protection.