As volatile as 2018 was in stocks, 2019 so far has been anything but. After the first two months of the year, market volatility has been nearly non-existent. It’s much closer to the ultra-low volatility environment of 2017, where the VIX barely cracked 15 the entire year.
Of course, we’re starting off from a higher volatility point due the crazy last few months of 2018. The VIX – the most common measure of market volatility – started off the year around 25 and is now just getting back to the 15 level. Investors have a long memory (depending on who you ask), so they aren’t yet completely ready to write off the turbulence of last year.
But it’s clear that market volatility has come way down as stocks have moved higher. Most of the concerns from 2018 have been set aside. The biggest piece of good news came from the Fed, which seems likely to be very patient when it comes to raising rates.
Once investors processed the bullish (dovish) stance of the central bank, the buy orders started flowing in. There’s still the China tariff war to consider, but there is (apparently) progress being made on that front. Plus, it appears the government isn’t going to go through another shutdown anytime soon – another source of volatility concerns last year.
But make no mistake… investors may be ignoring volatility right now but they haven’t forgotten about it. Shrewd fund managers and traders are using the opportunity to buy volatility hedges while it remains cheap. Don’t forget, volatility tends to move up in a hurry. There often isn’t a lot of time to buy market volatility for cheap once it does arrive.
One popular way to hedge against (or bet on) higher volatility is by using iPath Series B S&P 500 VIX Short-Term Futures ETN (NYSE: VXXB). VXXB tracks the first two VIX futures months, so it is a reasonable way to trade short-term volatility. Because it’s an ETN, the product is very convenient to trade and has very liquid options as a result.
Speaking of using VXXB to trade volatility, I came across an interesting trade which does just that. A trader purchased 2,000 of the March 29th VXXB 31-34.5 call spreads for $0.94 per spread with the share price at $30.72. That means the 31 calls were bought while the 34.5 calls were sold at the same time (to reduce the cost of the spread).
By paying $0.94, the trader is looking at a breakeven point of $31.94, but max loss on the trade is only the same premium paid. For 2,000 spreads, it equates to $188,000. However, if VXXB is at or above $34.50 by the end of March, max gain of $2.56 or $512,000 can be achieved. That’s a 272% return over the course of a month if it happens!
It may seem like a long shot for volatility to jump back up after how slow the year has been. However, any surprising news about the China trade situation or something similar could easily jumpstart market volatility. After all, there’s been no lack of drama coming from the geopolitical landscape in recent months."I'll write you a check for $100 if you don't make 5X your investment"
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