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The Move In the VIX Doesn't Matter

The way the VIX has acted over the past two weeks is something that I've not seen...

... probably ever.

The VIX has run from a low of 13 and spiked all the way to 21.


Now this move on its own is not too crazy.

In fact, I would consider this par for the course in terms of how volatility acts.

(And yes, I'm typing this on my laptop while watching the final round of the US Open. Golf is on my mind.)

What really sticks out here is the lack of price movement in the SPX.

Normally, price leads the VIX. If the market sells off, investors get scared and buy SPX puts... which drives the VIX higher.

Yet, the market has been absolutely quiet.



Sure the market has sold off, but the actual volatility sits under 9%.

As option traders, we want to watch the spread between the expected fear (using the VIX) and the actual fer (using historical volatility).

And the kind of move that we've seen absent ANY kind of true downside... well, I don't think we've seen it before.

It's All About The Brexit

The reason we're seeing such a strong move in the VIX without any kind of big selloff comes down to one thing:

The British referendum to leave the EU.

We are seeing expected fear "spillover" into equity risk premium.

Want to see something really crazy?

Here is a chart of FXB -- it's an etF for the British pound. It tracks the movement in the currency markets.


The lower chart shows the implied volatility for FXB options... basically the VIX for the currency.

Here's what I know about reading currency vol...

... anything above 15% and there's some serious shenanigans

... anything above 20% and the market's pricing something really ugly

... anything above 25%? It's not unprecedented but you only see it when the market has already crashed or is expecting a crash.

To put this in perspective, FXB vol hasn't been this high since the market crash in 2008.

This is where the "spillover" theme comes into play.

At some point, hedging currency risk gets too expensive to do.

So if you're a trader needing some "risk off" exposure, at some point you make the choice to pick up puts in the S&P 500 market instead of currencies.

That movement ends up building on itself, and all of a sudden the VIX has spiked to 20.

It's Getting Priced In

The bearish thesis here is that the VIX is full of "smart money" traders that are anticpating the collapse of western finance.

Thing is, I know plenty of stupid option traders. And given how saturated the vol markets are, it's very difficult to say that divergences like this are some kind of a big signal.

I am concerned about one thing... it seems when the markets really selloff there's some kind of move in currencies that really shake the markets.

The crash from August 2015? It was from a change in Chinese currency rates.

The pullback in January 2016? Related to the Fed.

The big drop in 2012 was from the "Fiscal Cliff."

And every summer swoon has been from Greece or PIIGS or some other risk out of Europe.

So of course, the Brexit vote could move the markets.

Yet this is something that we would call a "known unknown."

We know that a market moving event is coming, and a ton of people are hedging into the event.

What happens if everyone is hedged? Then the fear in the market disappates and the actual move in the market is lower than what is being priced in.

That's what this feels like right now.

Unlike, say, the Fiscal Cliff in 2012, if we do see a Brexit vote it will end up being a lot of risks drawn out over the course of months. It's not a straight up/down risk, but the market is pricing it in as such.

What's the Next Move

Here's my prediction on how this will play out...

It's very possible for the SPX to continue to selloff, maybe trade back to the lower end of the range.

Yet into any kind of selling, the VIX will not continue to skyrocket.

That's because traders will be using any downside action to take profits on their hedges... and the uncertainty surrounding the Brexit vote will start to get sucked out of the premium in the options market.

After that, we'll go back to the narrative that's dominated the market for a year now-- the "will they won't they" news risk around another Fed rate hike.

Now if I'm wrong... if the Brexit vote comes through and the VIX stays up... that's a bearish signal that the markets are about to break.

How To Profitably Trade The Volatility Markets

My favorite vol related trading instrument is VXX. It's a volatility ETN that perpetually sucks.

It's down like 99.999% since it started.

And we know it will perform like that because of how it's structured.

I have a very simple timing method to enter new trades in this instrument, and also how to trade it using options.

If you want to see how I trade this market, pick up the VXX Trader Course here.


5 Lessons To Learn From This SEC Investigation

Shocking news in the option trading world has come out recently.

A well known options trader has been involved in an SEC fraud investigation.

The easiest path to take here is anger, or perhaps to mock the whole situation.

And for those skeptics, a victory lap may be in order.

Yet I'd like to take a step back and see what we can learn from this. If you have any experience in options trading, this will be crucially important to read.

Before we dive into what potentially happened, remember that this is currently an open and ongoing case. Facts and revelations may completely change by the time it is settled.

I'm taking a few guesses here and I'm also pulling from my own experiences to give you crucial lessons if you want to succeed as an options trader.

Enter the Supertrader

A few years ago, a woman from Tennessee came onto a financial show and talked about her strategy. The headline was that "Karen the Supertrader" had earned over $41 million dollars trading this strategy.

She became a kind of a cult figure in the options world, showing how this simple strategy could be used by anyone to earn significant returns in the market.

Since the SEC investigation became public, the videos have been since taken down. However I have looked into the strategy her firm used as to whether it was possible to earn those returns.

Diving Into The Strategy

The way they earn returns is to sell options and profit from the time decay.

What made Karen's technique interesting is the use of margin.

She would "stress test" her positions, figure out how much stretch the market could have, and size up so that the value at risk was her net liquidation value.

So far, nothing out of the ordinary.

The returns she got were $41 million dollars.

Now, the only way to get those returns is by taking outside money.

Which is what they did. Her fund (Hope Investments) took in something to the tune of $90 million dollars. And with that size and the kind of market environment we had from 2009-2013, it was very possible to earn those kinds of returns by selling options.

What the Strategy Looks Like

Here's an example option strategy that would be similar to what Hope Investments would put on.

Sell to open SPX Jul4 1950/2200 strangle @12.00

The risk and reward is pretty simple.

If the S&P 500 trades above 1950 and below 220 going into options expiration, then you keep the credit of $1200.

There's other considerations here like position sizing, scaling in, scaling out and so on.


This is a "high odds" trade, meaning that you should expect to make money most of the time.

The tricky part is how you manage the trade when it goes wrong.

Where it Turns South

From reading the SEC investigation, it appears that things started to fall apart around the end of 2014.

That makes sense. A lot of option sellers got smoked then.


In case you don't remember the backdrop of this trade...

The ebola scare had started to take hold of the markets. The S&P sold of from 2,000 to 1,825 over the course of a few weeks. It got ugly out there.

That's probably not where things fell apart. It was on the rebound.

After the capitulation in October, the market rallied back to 2,000 just as fast.

And then it continued to squeeze.

Overeager option shorts started selling calls way too early. And too many people got short.

It setup the case for a massive short squeeze.

This happens a lot more than you think. A recent example is March of 2016, where Goldman Sachs put out a note that calls were way too cheap. The S&P rallied another 100 points since that call.

So in late 2014, coming into obvious resistance everyone sold calls too early. And call sellers got ran over.

When you are a net seller of options, the biggest risk is not to the downside... it's to the upside. It's much harder to manage a losing income trade to the upside.

So that's my guess here. They were doing fine, but then sold too many calls in size and got runover on the Ebola trade.

This in and of itself wouldn't be a problem with the SEC.

It's that they got greedy.

Bad Incentives

Once I read how they took a performance fee, I knew that it was the main reason why the SEC went after them.

A normal fund structure is "2 and 20." That means you take 2% of the total assets for overhead and you also get to keep 20% of any gains.

The fee structure for Hope Investments was 20% of realized gains...

Every single month.

When you sell options every single month, you can plan for that cash flow (until things go bad).

If you're trading your own accounts... not a huge deal.

But if you're trading serious size... man you can pull out a massive amount of cash every single month.

Yet if things go wrong, you can end up in a serious drawdown.

One way to manage those losses is to roll the bad options further out in time. You get stuck in the trade for another month, but it allows you to work your basis down in the position.

It's not a terrible strategy.

But when you tell your investors you "realized profits" on that roll... that's where you can screw up.

The monthly performance fee can set you up to be tempted in ways unimaginable when you trade your own accounts.

Consider this scenario...

You get smoked on a bad trade, and it may take 6 months to work back those losses.

That means you won't get that monthly performance paycheck for quite a while. The well has dried up.

But if you just do some fancy accounting, that gravy train can keep going... a very significant amount of money.

What would you do in that situation?

Would you have plenty of integrity and own up to your investors that you screwed up?

Sure it's easy to say sitting behind a keyboard...

Yet the incentive structure makes it an even harder decision to make.

They See Me Rolling...

When you get into a massive drawdown as an option seller, you can get stuck into the rolling trap.

You try and figure out some fancy options technique to get you back to breakeven, even if it takes you months to do.

I've been there. It sucks.

You may get you capital back, but you end up with a massive depletion of your psychological capital.

My guess here is that this is what happened with their fund, and they couldn't keep the numbers game going.

The Major Takeaways

I could go into a lot more detail about this case, but since it's ongoing I don't want to try and speculate too much on this.

Yet I think we have enough to get the lessons we need.

Lesson 1: Protect Your Capital

In terms of capital, I'm not talking about money.

I'm talking about psychological capital.

There are trades you can put on that are losers.

And sure... you can find a way to get it back to breakeven.

You can roll the trade, you can oversell spreads, you can convert a trade into an even more complex option strategy.

Yet there are some times you just need to take the loss and put your capital to more productive trades.

If you try and stick in this trade, you'll end up with blinders. You'll be so focused on working a bad trade to breakeven that you'll miss out on all the other opportunities in the market.

Lesson 2: Don't Blindly Use Odds in Your Trading

This is going to fly in the face of many other "gurus" out there, but I believe that using odds alone for your trading strategy can lead to disaster.

Say you sell an option. Let's say an AAPL Jul 90 put option.

Immediately, you psychologicall anchor onto that level.

And you start to say to yourself...

"There's no way AAPL can break 90."

It doesn't matter your religion, you must understand that the Market Gods exist.

And when you utter that sentence and send it to the universe...

The Market Gods hear.

And they reply:

"Oh yeah? We'll see about that."

At some point you're gonna get smoked on a trade.

How you manage that bad trade will dictate whether you will be successful at this game or not.

Lesson 3: Learn To Manage Risk

Here's the thing... I'm not saying that selling options straight up is a bad strategy.

In fact, I think the strategy they use at Hope Investments is incredibly lucrative and profitable in the long run...

... if you know how to properly cut your risk.

Blindly expecting the odds to eventually be in your favor is bad voodoo. The Market Gods will come after you.

The major risk in selling options is how your directional exposure (delta) can increase as the position moves against you.

Knowing how to manage that delta is half art half science.

But you have to do something.

You can use delta band trading, hedging with futures, buying options, buying complex spreads.

Will it cut into your returns? Of course. It's the cost of doing business.

But you still have to do it. Because once you get stuck into thinking "oh it'll come back..."

The Market Gods will hear.

Lesson 4: Don't Be A Dumbass Accountant

Take a scenario...

Say you sell an SPY 200 put option for .80.

And the market tanks.

So you buy back that put option at 1.20 and then sell another put option further out in time for 1.60.

Did you make money?

No, you didn't.

You have a loss of .40 from the closed option and no p/l from the new contract.

Stop deluding yourself.

If you roll options, treat it as a single position and track your basis on a mark to market pricing.

I've had people who have shown me trades where they got blown out on some put sales with massive losses... and it took them 9 months to get back to any kind of profit.

And they believe that they made money every single month through some BS accounting.

Don't lie to yourself, and especially don't lie to any of your investors.

Lesson 5: Limit Your Risk

I think selling options naked have a time and a place.

Yet if you're looking to create consistent, sustainable income from options while keeping risks low, then you should look to other trading strategies.

My favorite is iron condors. They are simple to manage and easy to understand.

The way we trade iron condors at IWO is a little different... we are much more aggressive in our risk management as we don't want to tempt the market gods.

If you want to learn all about iron condor trading, click here for your free iron condor toolkit.

A Continuation Pattern in IBM

After forming an island bottom back at the beginning of the year, IBM shot off like a rocket, running from 120 to 150.

It has since worked off its overbought condition and looks ready for another move higher.

Watch this video to see my technical take on the stock as well as an option trading strategy to consider.

3 Trading Outcomes for Apple This Summer

how-do-you-like-them-applesWhile the broad based indexes are spitting distance from new all time highs...

Things have not been as good in Apple land.

If you need to "blame" something, well you've got a long list.

Introduction of new competitors.

Poor iWatch sales.

Squeezing margins.

Whatever the case is, the big gap down that the stock saw after its earnings has probably priced in a lot of the bad news.

Yet, you can't just say the market is being completely efficient here.

If you can read the psychology of the market, then you can get a better edge in the stock.

AAPL Is Not A "Stock"

This may seem like a nonsensical idea, but AAPL really isn't a stock anymore.

(At least, you shouldn't treat it like one)

Sure, it represents the underlying shares of a company...

But that's not why many people trade it.

Think about it:

This is the most heavily traded, liquid stock in the world.

It's liquidity rivals many other broad-based markets.

In fact, we can go so far to even call it a mini-index!

AAPL has more in common with gold futures than it does other stocks.

It's more a source of liquidity and a store of value.

Think about it, if you're a fund manager that has a mandate to be invested 95% in stocks...

Meaning you can't hold a cash position...

You can't just park it in anything.

If you want to get in and out of an asset quickly, you don't want to have a bunch of slippage.

So what do you do?

You park it in AAPL... not just because you think the company is good (well, you still think it's good), but also you can sell your shares quickly without dumping the stock.

At some point the company matters... and we see that when the stock gaps around on earnings.

Have I convinced you a little bit?

This matters because the way you trade indexes and commodities is a little different than how you trade individual stocks.

Higher liquidity leads to more mean-reversion.

With that in mind...

A Look At The Chart


This is a weekly chart of AAPL.

If you could put this chart into a single word or phrase, what would it be?

Optimism? Sure doesn't look like it?

Panic? I don't think so.

When I look at this chart I see "impatience."

This impatience stems from a few areas.

First, we have the true believers in the company. They're invested for the long run and they actually care about the fundamentals.

Well, up to a point. Because if you aren't making money from it, the mood can easily sour.

Those fundamental investors are looking at a nasty gap down on earnings due to disappointing numbers.

And all those people who say they hate technical analysis... they're lying because they've got this exact chart pulled up, watching this level at 93.

The second group are the "liquidity" crowd, who use AAPL as a trading instrument and a way to "store value."

(In fact, I think AAPL and gold have a lot in common. Strong opinions held both in the bull and bear sides, and both assets only trend maybe twice a year. Food for thought...)

This liquidity crowd is growing impatient because AAPL stopped going higher.

I know it sounds stupid simple, but if you're parking your money in an asset, you'd like to see that asset rise.

And when stocks go down, liquidity tends to dry up.

I think the past few months has been an unwind of those who have used AAPL as a trading vehicle.

There's probably another few "profiles" we could build out in terms of who is playing the stock, but no matter what...

Everyone is looking at the 93 support level.

And what happens when everyone looks at the same level?

That's where I get my trade ideas from.

The 3 Trades to Consider

The first trade possibility is the failed breakdown.


Because everyone is looking at this support level, it will have a higher initial failure rate.

Think about it...

If you're scared about a breakdown in AAPL, odds are you've already sold. You're not waiting for the actual break.

What ends up happening is the breakdown has no followthrough at all. Once investors and traders start seeing that in the tape, they pile on top of one another to reenter at a "better" price. This takes us back to 93 and probably a swift move to 100.

The second scenario is the all clear fade.


In this case, the 93 level holds and we start to head higher.

The sentiment quickly shifts and the earnings gap gets faded. Complacency hits and we head back above 100, which is a big psychological level in and of itself.

If we bounce hard here, there will be a good shorting opportunity into that 100 level.

The third is what I would call a dip buy failure.


If we get a clean break under 93 with proper followthrough, we'll find a point where all energy has been spent in the short term.

The first "dip buyers" will come in here, and hope for a bounce.

Odds are the first dip won't be the final move.

We'll need to wait for those dip buyers to get stopped out.

Into that stop out will be a great long term entry point on AAPL. I'd look at selling puts or doing a covered strangle.

It's Like Poker

The way to truly be successful at poker is understanding the motivations of the other players at the table.

The same holds true for stock trading.

Everyone has the same data.

Everyone has the same charts.

The way you win is taking it one step further and learn the motivations of the other participants. From there you can get better reward to the risk you take and build wealth over the long term.