Conflict in Syria, worries about Russia and North Korea, and an unpredictable government at home could send the stock market tumbling at any moment. Here’s how to profit from a temporary market dip.
Stock market volatility continues to confound traders and investors as the VIX and other major volatility trackers close in on all-time lows. The VIX itself closed at its fourth lowest level ever last week, and has been struggling to remain above 10 – a level once considered a floor for the widely followed index.
It’s as if market participants care nothing about risk, or at the very least, believe there is no genuine risk to owning stocks on the horizon. Once the French election ran its course, all thoughts of rising volatility have apparently been abandoned.
What’s interesting is that the US government has been anything but stable. It seems like every day there’s another potential scandal on the way, the most recent one being the unexpected firing of the FBI Director. But by keeping volatility at low levels, traders are suggesting that nothing that happens in the White House will spill over to Wall Street.
Take a look at this chart of the VIX:
It’s almost like traders are racing to see who can sell volatility faster. And who can blame them… It’s a strategy that’s been making money over and over again in recent years. Still, selling volatility for a living is no way to live. It will work – until it doesn’t – and when it doesn’t it will be more painful than anyone can imagine who wasn’t in the markets in 2009 or 1987.
That’s not to say there aren’t long volatility trades occurring. In fact, I just came across a very interesting one recently in ProShares Ultra VIX Short-Term Futures ETF (NYSE: UVXY). UVXY is a leveraged ETF which tracks short-term VIX futures and attempts to return double of what the VIX is doing.
As you can imagine, UVXY has gotten pummeled over the long haul with volatility continually being sold. On the flip side, this ETF should move twice as fast on the upside should volatility spike for any reason.
Here’s the thing…
Someone purchased about 4,300 UVXY 1 calls expiring in January of 2018 for roughly $11.50 per contract. Now there are several interesting things about this trade. First off, someone is spending a ton of money ($4.95 million) to get double long volatility. Also, by purchasing January 2018 options, this person is obviously willing to wait for the spike to happen.
Okay, but how about buying that 1 strike? UVXY is right around $12.50, why purchase such a low strike? Basically, when a deep in-the-money call is purchased, it means the buyer wants the options to act just like stock. A call so far away from the stock price will move 1 to 1 with the stock.
This then begs the question, why not just buy the stock itself? By purchasing options instead of stock, the trader is saving a big chunk of money because of leverage. You see, the equivalent of 4,300 calls is 430,000 shares. At $12.5, buying UVXY outright would cost nearly $5.4 million. Using leveraged options, the same share control only costs $4.95 million. That’s a savings of $425,000!
As I’ve said many times before, the leverage of options is one of their most appealing qualities. Plus, there’s no reason you can’t make a trade like this, even at a smaller scale. Instead of buying 100 shares of a volatility ETF, save yourself some money and buy a long-term, deep in-the-money call.
I’m not a huge fan of leveraged ETFs as they can be very risky. Instead, I recommend doing a similar type of trade using VIX options. For instance, the VIX October 9 calls are trading for $6.70. That’s just $670 per contract for over 5 months of long VIX coverage, which should move close to 1:1 with the underlying.
Of course, choose a strike and product you’re comfortable trading. Just keep in mind, in just about any situation where you want to buy stock, options are usually the better choice.