Using
Volatility Instruments as a Trading Instrument
The
study is on how to profit from trading volatility instruments. Over the last
couple of months due to the current market price I have been trading Volatility
products, in the VIX, SVXY among others. In this blog I specifically want to
write about the VIX and SVXY and how to trade these instruments.
There
are a lot of articles and quality information on the internet about how they
are structured and how they derive their underlying value so I have no
intention of going into that space. What I want to go into is what to look for
and how to trade these instruments.
The
SVXY is inversely correlated with the VIX. The SVXY influence is from Contango
which means it should have a positive drift due to that the contango affect
which happens about 90% of the time. This article is not to describe any
terminology, as there are a lot of articles already written on the internet. But
rather I am highlighting these as an investment opportunity to hedge or add to
your portfolio as a trade-able instrument.
Chart
provided by yahoo.
When
the SPY drifts up over time and where the environment will decrease volatility,
the VIX will continue to fall, when the SPY falls or crashes and making
volatility increase the VIX will increase in value, quickly.
A
problem with trading these instruments is the cost to carry, but they can be a
fantastic instrument to profit from in short time periods.
Look
at it this way, the SPY was making all time highs, and in my opinion slowing
down, I looked at the VIX and noted that it was trading below 12.5. This is an
incredibly low value, quickly scanning historical charts I noted that from this
low value, it did not take long for the VIX to rally, most of the time within 4
month period. So in light of this I bought a call, with the anticipation that
the market was at all time highs and that the VIX was at lows and with the
expectation that the market would make any sort of correction which would allow
the VIX to increase in value. Sure enough the SPY only pulled back 4%, but on
my VIX call trade I made about 90% of my investment in 2 weeks. Why? Well in
that small pullback that the SPY made, the VIX rallied 90% going from roughly and
below 12.5 to a high and close of above 23.
The
SVXY trade would have been to wait for the VIX to rally, which means that the
SVXY would fall in value. Because of the positive drift in contango and
expectation that it will over time move higher this trade creates those potential
opportunities. What I mean by this, is that there are opportunities to trade
both sides of the volatility with a long basis on both but trading opposite
sides of the volatility move. That same trade movement the SVXY moved from a
high of about 77.50 to a low of about 57.50 to roughly 68 where it is now. That
is roughly a 26% fall in the underlying followed by a rally of over 20%. This
is a substantial price movement and swing. When volatility spikes, a trader
could easily, buy calls or sell puts or what ever instrument that they desire
and that fits their investment strategy and Return on Capital and or gives the
trader the biggest bang for their buck, in light of their risk profiling for
the underlying and strategy.
A
word of caution, picking tops and bottoms and trading tops and bottoms is a
sure way to give your money back to the market. Reversion to the mean is an
added incentive to help determine the potential move of a underlying, but bear
in mind that reversion to the mean is just an mathematical output and there is always
a probability that it will continue moving away from the mean. I have this to
offer and that is trade small, and have multiple reasons why the stock is
favored to move in the direction of your positions. If the underlying moves
further from the mean and all outputs of data are still showing that with your position their is a greater/higher
probability of success, at times like these it may be a fantastic opportunity
to continue and reduce your cost basis so your break even moves further from the
mean or target profit price. Which in turn creates greater profits when the
underlying moves back to the mean or target price.
From the studies and research i have completed, Philip Fisher says it best with his quote; “Far more money has been lost by investors
preparing for corrections, or trying to anticipate corrections, than has been
lost in corrections themselves”.
All
prices quoted are approx due to there is no point being accurate as every
person reading or trading would be trading at different times and different
prices. This way it is general but specific enough to get the point across.
