The Wall Street roller coaster just entered death mode. So hide the kids, hoard the pepto bismol, and consider queuing up a trade or two on your VIX ETF of choice to welcome our new volatility overlords.
To get a sense of just how extreme the fear and anxiety became during Monday’s crash look no further than the CBOE Volatility Index (VIX).
At 53.29, yesterday’s VIX peak reached a level rarely seen. The dot-com crash, flash crash, and 2011 European sovereign debt crisis were all insufficient in driving the VIX as high.
Only in the height of the 2008 panic when Armageddon came to town was the VIX able to rise above Monday’s heights. So consider yesterday’s fear jump almost unprecedented.
Of course, the severity of the panic didn’t last long. Once stock prices began to snap back, the angst descended to more sane levels. And with today’s desperately needed up-gap in equities, the CBOE Volatility Index has returned to the 30 zone.
Which is still high, mind you. It just has a bit less of an oh-my-gosh-the-world-is-ending feel than Monday’s insanity.
While some volatility spikes come and go like a thief in the night, most suffer a few aftershocks before the crisis du jour has passed. In other words, VIX spikes often cluster together especially in times of extreme distress like 2008, 2011, and most likely now.
So here’s how you play it.
The VXX Trade
A number of CBOE Volatility Index related ETPs (exchange traded products) have burst onto the scene in recent years. The king of the hill — at least in terms of popularity – is the iPath S&P 500 Short-Term Futures ETN (VXX). VXX scored a record volume day yesterday with more than 269 million shares traded.
It’s not a perfect proxy for the VIX, but does an okay job of tracking it in the short run. After tagging $28.22 amid Monday’s bloodbath, VXX has dropped back down to $22 today on the heels of the stock rally. If you think we’ll get another plunge into the abyss, then buying the dip in VXX here makes sense.
Options on VXX are currently quite expensive, making short premium plays all the more attractive. The cheaper price tag of the VXX ETF suggest short puts could generate a solid return on investment.
Sell the Sep $18 put for 75 cents or better. Consider it a bet that VXX remains above $18 for the next month — which it certainly should if the market turmoil persists. The max reward is limited to the initial 75 cent credit.
If your broker holds aside 20% of the price of VXX in collateral for the short put play, you’re looking at about a 16% return on investment ($75/$460).
By selling the put, you obligate yourself to buy 100 shares of VXX at $18 should the stock descend below that level by expiration. To avoid assignment and limit your risk consider buying back the put if it moves in-the-money.
At the time of this writing Tyler Craig had no positions on any of the aforementioned securities.
