When the average investor is panicking during a market drop the smart money is selling Volatility.
We outline a strategy below for investors:
The VIX index which trades on the CBOE is a real time measure of investor fear. It measures the SPX index option level and is a 30-day forward looking gauge of risk and sentiment. It spikes the quickest during short, sharp drops in the SPX. Fear always subsides with the exception of the end of the world and that can happen once so why worry. The VIX to the market is similar to a ball in relation to gravity: it always comes back down. Many institutions and Wall Street icons sell volatility against existing long term positions or make pure bets against the VIX itself. It is a trade where you can get rich slowly as it gradually subsides. This can be done by purchasing a number of inversely related ETF’s that go up as the VIX drops such as SVXY. This particular ETF inversely tracks VXX, a volatility ETF. Some ETF's are more leveraged than others which increase potential gains but also increase decay and risk. Leverage is a double edged sword and we do not favor it in betting with or against the VIX as these trades can often take weeks or months to play out so decay becomes a dominating factor.
It is our opinion the VIX just put in a multi-year top and we will have to wait until 2022-2024 to see that level challenged again. The beauty of the SVXY trade, shorting the VIX, which is betting that fear subsides is two fold. First, if the market stays in a whipsaw mode and in a tight consolidation making no real progress up or down the VIX will gradually drop. Secondly, if the market experiences a rally the VIX will also drop. It is hard to find lower risk trades which offer profit potential of 15-25%. There are no guarantees in the stock market but this is a trade that can pay off on a consistent basis. Key points to increase your odds of success are limited use of margin and leverage. Also, if one tries to short the VIX via options, deeper in the money and plenty of time are two more points that will increase your odds of success.
So they next time the pundits on TV and the average investor is screaming the world is ending, consider selling some volatility to profit from the chaos.
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