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How to Trade the VIX/VXV Indicator

During this most recent market pullback, I’ve been getting a ton of interest about an options-related indicator that I use to help my market timing.

In this post, you’ll see how to construct this indicator, why it works, and the trades to consider to take.

Enter the VIX

The VIX is a 30 day reading of the implied volatility on the SPX options board.

Basically, it’s a way to measure the demand for options. And most of the time, the demand for options is when volatility picks up.

And most of the time, volatility picks up when stocks are selling off. That’s because the demand for liquidity is different when people are being forced to sell compared to when they are being forced to buy.

If you’ve had any experience with the VIX, you know that high VIX readings can signal a “panic” and mean that the market is ready for a turn back to the upside.

But sometimes the VIX can be fickle, and it doesn’t properly show us how panicky it is on the short term.

Comparing to the VXV

The VXV is a 90-day reading of the implied volatility on the SPX options board.

Because this is a longer duration, the options tend to be less sensitive to the “near term” issues affecting the market.

And if there aren’t many near term market risks, then the VXV will trade at a premium to VIX because we are much more uncertain what will happen 3 months out compared to one month out. I call this the “just around the corner” trade where nobody thinks the market will selloff, but something is just around the corner so investors will buy longer dated options and sell near term options.

Here’s what the VIX/VXV chart looks like:


When We See Panic

If there is a clear and present danger to stocks, then investors start to get scared.

And because the risk is so close and they are so scared, they start buying shorter term protection via SPX puts, SPY puts, VX futures, VIX calls, or some other instrument that would eventually effect the VIX.

You can also have investors buying protection on individual stocks like XOM and GS, and the market makers will eventually arbitrage the volatility out.

If the short term fear gets high enough, we will see the value of the VIX become larger than the value of the VXV.

Technically, you could see a similar relationship when the VX futures curve goes into backwardation — where the near term VX future is at a higher price than long term. But using the VIX/VXV will give you the ability to chart this a little quicker.

Panicky markets tend to also be right around where they bottom. That means when the VIX/VXV goes above 1, you should be looking for new swing lows to be put into place.

Here’s a weekly chart of the SPX with the instances we see VIX>VXV:


What you’ll see here is that this signal did come through during the 2008 crash and had you bought the S&P off of this signal, you would not have done well.

That’s because, like many other oversold signals, they should be taken in the context of the trend. If the market is in a downtrend, then oversold can become much more oversold. Don’t chase holy grails, and have some nuance in your market analysis.

Since the market started its new cyclical bull market in 2009, the signal has performed exceptionally well.

Some Quantitative Results

Chad Gassaway was kind enough to put some numbers to the relationship:


While this only goes back to 2010, it can help you draw some conclusions:

  1. This indicator doesn’t flash very often. It’s only when we have market driving event risk (debt ceiling, QE fallout, Eurozone crises) that this will show up. This is not meant to be a super short term timing indicator with a ton of entries and exits.
  2. It tends to be a bit early. When we see panicky markets it’s often justified in the near term as we see high actual market volatility both to the upside and downside. As time goes on and sellers run out, that’s when the market will bounce.
  3. It is a high odds signal, but when you’re wrong you are wrong big. A great example of when this signal fails was the summer of 2011 when the S&P downgraded the US credit rating. That means this signal is not meant for you to go 100% long stocks, but it fits better in the context of option traders that like to sell premium and can aggressively manage risk.

How to Trade It

This signal is not meant to be a “BUY EVERYTHING” kind of setup.

When you see this signal show up, it should perk your ears up and you should start looking for dip buys that you have been avoiding.

And if you had put on some market hedges or shorts, this signal provides you key market levels to define stops or adjust your hedging positions.

Here are some other trades to consider when we see this signal:

  1. Short the VXX. This is a volatiltiy ETP that does quite well when near term volatility is running hot, but it is not a condition that persists forever. A good risk structure for shorting the VXX here is 3 month duration puts, or out of the money put calendars.
  2. Relative Strength Bull Put Spreads. Find the names that haven’t been following the broad based market selling and start selling premium in those names. You could try and nail the bottom on stocks that are extremely oversold, but I’ve found it’s easier to preserve psychological and financial capital if you stick with stocks still in uptrends.
  3. Reversion income trades. This strategy set uses fixed risk trades like butterflies and calendars on broad based market etfs that look for reversion back to the mean. This generally means that stocks are going to pop, bonds (TLT) are going to drop, and near term volatility is going to get hit. That last point is the most important– if you are a net seller of shorter duration options and volatility gets crushed as a market moving event passes, then you stand to profit nicely.

At the time of this writing, we are seeing these conditions present themselves, and I’ve been sending out trade alerts on all 3 of those strategies. If you want to become a great options trader, then start a trial of IWO Premium today. Click here to learn more.

Take this Trade Into Any Holiday Season for Some Quick Profits

holiday-volatility-moneyWhat if I told you there’s a simple way to bet that holiday trading is going to be quiet?

Ok, not so simple…

But this post will take you through a very specific option trading setup that profits right before a holiday trading season.

It doesn’t have to be Christmas. It can be any time of the year where there is a short trading week in the markets.

Keep reading to discover how to execute this trade for profits.

Hey, Where Did Everybody go?

If there’s one thing we know for certain, it’s this:

During market holidays, the total price movement in stocks is 0. That’s because the markets are closed and there’s no trading going on.

The next point is almost as certain:

Right before market holidays, the total price movement in stocks approaches 0.

Why? It becomes a self-fufilling prophecy. If everyone knows the day before Christmas or the Labor Day weekend is going to be quiet, they’ll take the day off. Liquidity dries up, institutions can’t push through new orders, and the market just grinds in a tight price range.

With those two assumptions, we know that the volatility in the market running up to a holiday season will be very low.

Take Advantage of The Silence

Even though quiet holiday trading happens very often, the options market doesn’t respond to it very quickly. The options market will tend to keep their options premiums, assuming that we will have normal volatility up to and through the market holidays.

This is where you can profit.

If the options market is expecting normal volatility, and we know that heading into the holidays we have lower volatility, then you want to be a net seller of volatility.

What you’ll see in the options market is that as we get closer and closer to this holiday season, that’s when the options market finally responds and the premiums drop in the market.

And that’s where your profits come from.

How to Structure Your Trade

There’s one more thing that’s really cool about this scenario.

The option premium that drops into the holiday season only happens with near term options — that means options that have 30 days or less to expriation.

Because longer date options are around for longer, the lower volatility in the market will matter less, and the option premiums will hold up well.

So we can short volatility on the near term options, and get long volatility on longer term options.

This is called a calendar spread.

Still with me? Good.

Trade Example: Christmas Break Trade

On November 24th, I sent out an alert to IWO Premium members to put on this trade:

Buy to Open SPY Dec/Jan 207 Put Calendar for 1.27

More specifically, this trade sells the Dec 207 put, and buys the Jan 207 put.

The directional exposure from the short option is cancelled by the long option, so this is a delta neutral trade.


The trade thesis here is that the premium on the short option will come out faster than the long option.

This premium will get sucked out not only from the normal time decay, but it will be accelerated from the options market pricing in the slow holiday season.

After two weeks, the trade was closed for a profit of 20% on the spread:


Before we move on, just remember: standard disclaimers here. Past performance is no guarantee of future performance, and this assumes perfect fills. Some people did better on this trade, some did worse because execution, liquidity, and fills matter.

You may be looking at this risk profile and wonder why this trade isn’t held all the way to expiration to try and max out the gains.

The problem with that is if you try and hold the trade longer, it puts you at risk of more volatility. Income trades like this have a profit target of 15-30%, and it’s better to take profits and reenter at a better basis.

Trade Example: Labor Day Trade

On August 25th, 2014 I sent out a trade alert for this trade:

Buy to open SPX Sep/Oct 2000 call calendar for 11.15

My trade thesis was that the market would start to cool off as we headed into the Labor Day weekend.

This trade is interesting because it really goes into how the different implied volatility on each contract can affect the pricing of the calendar spread:


During this time, the implied volatility on the overall market was quite low– the VIX was in the 12’s, and these options had an implied volatility in the single digits.

So what happened in two weeks?

The market didn’t go anywhere, the premium in September got sucked out while the premium in October held strong, and the implied volatility in October actually rose:


This trade profited not only from the premium drop in the time decay, but also from the rise in the implied volatility that helped to boos the value of the October option.

Simple, but not Easy

This trade doesn’t come along very often, but it is a subset of the kinds of calendar trades I like to take.

I’ve spent a good part of 2014 honing my skills and knowledge around calendar trades, because it’s an income trade that does well in a low volatility environment.

If you’d like to learn more about how calendar trades work, then read my report on “Profiting in Low Volatility Environments.” Read the report here.

Making a Profit From a Sideways Yahoo

YHOO Options TradeUsing a simple “parabolic” setup, I was able to pull over 30% out of a YHOO position in under 2 weeks. Want to see how I did it? Read this post for a full trade rundown.

Understanding the Setup

When a stock has a big breakout on earnings, it has a tendency to continue in the direction of the breakout.

This is known as Post Earnings Announcement Drift, or PEAD. It’s a very well-known phenomenon in stocks and is well documented in financial research.

But what happens after the honeymoon is over? Does the stock collapse outright or does something else happen?

In my experience, stocks that see massive breakouts on earnings will tend to have 2-3 weeks of really good price action. After that, the stock then becomes rangebound rather than seeing any kind of parabolic blowoff top.

Keep in mind that my experience is more towards large cap, large float stocks… the trade is completely different if you’re dealing with low float or penny stocks.

If you come from a directional trading background, you may think that a rangebound stock offers little in terms of profits.

But with options trading, the simplest profitable trades often come from stocks that want a pause.

Here’s the Trade

On November 14th, I decided that YHOO had seen enough of a move to the upside and was ready for rangebound action. I made this call based off of the duration of the rally, the lack of any substantial pullback, and some other technical readings.

The trade alert I sent out to IWO Premium members was:

Sell to Open YHOO 50/45 put spread for 1.30

Sell to Open YHOO 50/55 call spread for 2.00

This trade is known as an iron butterfly. It’s called “iron” because it uses both calls and puts.

Here’s what the risk looked like:

I need to provide a little more explanation to this trade.

If you just look at the breakeven levels at options expiration, you may find that it has terrible odds that this trade will be at a profit, simply because YHOO moves much more than the profitable range.

The way I structure these trades is to scale into the trade. If YHOO continued to squeeze, I would roll the call spread higher– this would mean I am committing more capital to the trade and reducing my max reward in exchange for better odds. The overused phrase in trading is “never add to a loser,” but it’s different with option income trading and if the adds are preplanned, the size you take is lower and it’s good risk management.

The Outcome

This trade ended up needing no adjustment as YHOO failed to squeeze much higher after that.

Here’s what the trade looked like after two weeks:

After the pullback on December 1st, we were able to close out the trade for a 35% return on risk, after a holding time of 2 weeks.

The goal profit target on these kinds of trades are around 20%, so this trade ended up working out great.

Is this a complex trade? You bet.

It takes a little work to understand how to take these trades, and that’s why I’m here.

If you want to get trade alerts along with a world class options trading education, then you should join my trading service.

You can take a test drive, too: 2 weeks for $14.

Signup here.

NFLX is Ready to See a Very, Very Large Move

Just like price, volatility moves in cycles. When we see volatility compression for too long, it becomes a high odds bet to get long volatility.

Take a look at a daily chart of NFLX. I’ve put on a few Bollinger Bands on here to show you how tight the price range has become.


Basically, the stock had a nasty gap down on earnings, faded that downmove, and hasn’t done anything since.

First up, I’m looking for a little shake and bake this week as options expiration is Friday and we’ll probably see some shenanigans.

If a big move doesn’t happen by Friday, then you really need to look at buying volatility goingn into Christmas.

Update to the Call

I’ve received a handful of emails asking specifically what trade was taken here.

Since I had a feeling that there would be a large move in the near term, I sent out this trade alert to IWO Premium members:

Buy to open NFLX Nov 382.50 straddle @9.40
Sell Nov 395 call @0.98
Sell Nov 370 put @1.04

This trade is known as an iron butterfly buy. It could also be called a “covered straddle.”

I really like this trade structure because it eliminates the time decay risk faster than if you had put on a straight up straddle. The tradeoff here is that it limits your maximum profit potential, but because this is such a short term trade it doesn’t matter that much to me.

Here’s what the trade looked like:


After a single day, NFLX had sold off aggressively and the trade did great.

Here was the closing order:

BUY to close Nov 370 Put @7.00
SELL to close Nov 382.50 straddle @ 17.71
BUY to close NFLX 395 Call @0.17

Which ended up being a return on risk of around 40%.

Here’s what the trade looked like after:



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A Complex Spread That Gives You 10% Returns in Just One Month

If there’s any super obvious theme in the markets right now, it’s the rotation out of risk.

This means small cap stocks have been underperforming the market and have the potential to make a longer term top.

It’s Getting Ugly

A look at the Russell 2000 shows how much damage has been done:


After an attempt to stabilize around 1160, sellers stepped up aggressively on Friday and we have seen continuation to the downside.

Is this a long term top?

I don’t know.

I trade options that are a month or two out, so I don’t have to worry too much about it.

But since the Russell has been selling of so hard, investors are getting scared and bidding up the implied volatility in RUT options.

And most of the demand has been on out of the money puts as investors fear extreme downside rather than moderate downside.

Taking the other side of this trade is what I want to do.

The Trade Setup

Buy to Open RUT Oct 1090 Put

Sell to Open 2x RUT Oct 1080 Put

Buy to Open RUT Oct 1060 PUt

Credit: 1.10

This trade is a broken wing butterfly. It’s called “broken” because the distance between the long strikes are not the same. This helps to bias the trade so you can collect a credit on a move higher.


The Risk and Reward

This trade makes money a few ways:

1. If the RUT rallies
2. If the RUT sells off slowly
3. If the RVX goes lower
4. If the option skew goes lower

Given how far we’ve sold off already, all of these seem like good odds.

The major risk here is if the RUT sells off aggressively. The downside breakeven at options expiration is 1070, which would require another 50 point selloff in the RUT. This is unlikely, but possible.

The maximum capital required in this trade is $890.

If RUT rallies you keep the credit of $110, giving you a return on risk of about 12%.

If RUT continues lower but settles around 1080, you can see outsized returns, but the odds of that are very low.

If you want to see how we do this in real time, get a 2-week pass to IWO Premium for $14. Trade alerts, nightly videos, video training, and a chat room. Get the pass here.