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Dear Friend,
VIX, the so-called “fear index” hit a 5-year low last week. What does that mean for investors, and how can they capitalize on this new development?
Terry
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| Option Tip of the Week |
The most popular measure of options prices is the average implied volatility of puts and calls of the S&P 500 tracking stock (SPY). (Only monthly options are included in this measure, and the increasingly-popular Weekly options are excluded, a serious mistake in my opinion.)
The mean average of VIX is 20.54. When VIX is below 15, options prices are considered to be extremely low and when VIX is above 35, option prices are considered to be unusually high. In the crash of 2008, VIX rose to 80 briefly and then fell all the way back to the mean average in about a year. More recently, about a year ago, VIX rose to 40 when the possibility of a European economic meltdown was making headlines.
When fear is high, option prices as measured by VIX are high, and vice versa. Last week, VIX fell to 13.30, a low number not seen for five years. Investors seem to have little fear. By historical standards, they are complacent. After all, the market has moved higher for six consecutive weeks.
But the market is driven by sentiment. And sentiment changes. One interesting thing about VIX is that it ultimately moves toward its mean average. Reversion to the mean is just about the most powerful thing that we know about VIX.
At this point in time, a single news story that Greece or Spain or Italy might encounter difficulties refinancing their debt, or China is slowing down, or Israel bombs Iranian nuclear plants, and VIX will soar through the roof.
So how do you make money when VIX rises (as it inevitably will)? You could buy calls on VIX, but they are expensive (since everyone knows that VIX is bound to rise sometime), and you lose money if VIX stays flat (or only moves slightly higher, not enough to cover the cost of your call).
One serious problem with options on VIX is that you cannot place spreads (such as calendars or diagonals) with long and short options in different months without posting extremely high cash margin requirements (and you can’t do it at all in an IRA).
There is a better alternative out there, and it is a proxy for VIX. It is an ETN (Exchange Traded Note) called VXX. It is based on the futures of VIX and is highly correlated to VIX. Last Friday, VIX closed at 13.45 and VXX closed at $11.20. Last fall, both numbers were about at the 40 level, and in 2008, they both got as high as 80.
Of course, you might just buy VXX and hope that VIX rises, but there is a problem with owning VXX for the long run, and that is a thing called contango. We can’t discuss contango at this time, but essentially, it pushes down the price of VXX about 8% a month at today’s futures prices, all other things being equal (i.e., VIX and VIX futures remain flat).
Our preference for betting that VIX (and VXX) will rise when VIX is at unprecedented low levels is to buy calls on VXX (right now, one of our 8 portfolios owns VXX calls expiring on September 21, 2012). We sell at-the-money Weekly calls against these long positions, but we only sell enough calls to cover the premium decay on our long call positions. We have 50% more long calls than we have short calls.
If VIX stays flat, our portfolio should break even (compare this to buying calls on VXX which would lose 100% of their value if VIX remains flat, or falls). If VIX moves slightly lower (unlikely, in our opinion), we should lose a little. If VIX moves slightly higher, we should make a small gain. If VIX moves significantly higher, we should make a windfall gain, maybe five or ten times our total investment.
We believe that our portfolio (we call it the Honey Badger portfolio) provides exceptional protection against a 1987-like market meltdown. Last week, one writer, Todd Feldman, saw similarities between today’s market and the market in 1987, just before the crash – see it here if you are interested.
If the market crashes for any reason whatsoever, or if VIX moves significantly higher for any reason (or for no reason other than reverting to its mean), our Honey Badger portfolio should yield huge returns.
You can mirror our Honey Badger portfolio, or any of our other seven portfolios, and not have to make a single trade on your own, through the Auto-Trade service offered by TD Ameritrade/thinkorswim.
To celebrate the re-establishment of Auto-Trade at TD Ameritrade/thinkorswim, we are offering our Premium service at the lowest price in the history of our company. We have never before offered such a large discount. If you ever considered becoming a Terry’s Tips Insider, this would be the absolute best time to do it.
And now for the Special Offer – If you make this investment in yourself by midnight, September 4, 2012, this is what happens:
1) For a one-time fee of only $75.95, you receive the White Paper (which normally costs $79.95 by itself), which explains my favorite option strategies in detail, 20 “Lazy Way” companies with a minimum 100% gain in 2 years, mathematically guaranteed, if the stock stays flat or goes up, plus the following services:
2) Two free months of the Terry’s Tips Stock Options Tutorial Program, (a $49.90 value). This consists of 14 individual electronic tutorials delivered one each day for two weeks, and weekly Saturday Reports which provide timely Market Reports, discussion of option strategies, updates and commentaries on 8 different actual option portfolios, and much more.
3) Emailed Trade Alerts. I will email you with any trades I make before I make them so you can mirror them yourself or have them executed for you by TD Ameritrade/thinkorswim through their Auto-Trade program. These Trade Alerts cover all 8 portfolios we conduct.
4) Access to the Insider’s Section of Terry’s Tips, where you will find many valuable articles about option trading, and several months of recent Saturday Reports and Trade Alerts.
5) A FREE special report “How We Made 100% on Apple in 2010-11 While AAPL Rose Only 25%”.
6) A free copy of my e-book, Making 36%: Duffer’s Guide to Breaking Par in the Market Every Year, In Good Years and Bad (2012 Updated Version).
With this one-time offer, you will receive all of these Premium Service benefits for only $75.95, (normal price $119.95). I have never made an offer anything like this in the eleven years I have published Terry’s Tips. But you must order by midnight on September 4, 2012. Click here, and enter Special Code Auto12 in the box on the right side of the screen.
I feel confident that this offer could be the best investment you ever make in yourself. Celebrate the resumption of Auto-Trade at TD Ameritrade/thinkorswim with us. But do it before the day after Labor Day, as this offer will not be available after that day.
I look forward to prospering with you.
Terry
P.S. If you would have any questions about this offer or Terry’s Tips, please call Seth Allen, our Senior Vice President at 800-803-4595. Or make this investment in yourself at the lowest price ever offered in our 11 years of publication – only $75.95 for our entire package using Special Code Auto12.
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| Andy's Market Report |
I’m sure many of you have already seen the latest financial headlines.
News of the S&P 500 advancing for the sixth straight week, coupled with the VIX tumbling to a five year low dominated the airwaves shortly after the closing bell Friday.
On the surface the news sounds great, right? Of course.
But, if you dig a little deeper you will quickly find that the last two weeks have seen the lowest volumes of the year. Without conviction, the latest move has to be questioned for its validity.
As I have stated over the past few weeks, I expect to see an intermediate-term decline over the next several months.
The S&P 500 (NYSE: SPY) has pushed back to near multi-year highs. Simultaneously, the major market index has pushed into a “very overbought” state.
But more importantly one of the most reliable market indicators is signaling an imminent decline. The indicator: The CBOE Market Volatility Index (VIX).
The VIX serves as a "fear gauge" for the S&P 500. The index measures the prices investors are willing to pay for options that protect the value of their portfolio. The lower the VIX, the less investors will pay to insure their stocks – hence the less scared they feel.
When investors and traders become complacent, a market reversal is typically on the horizon. And I see no reason why this time should be different.
As the market has rallied, volatility has contracted to near-historic lows. In fact, as of Friday the VIX moved to a new five year low of 13.43.
The VIX is now down more than 50% over the past three months after trading around 28 when the S&P 500 bottomed in late May. Again, on Friday it dropped below 14 for the first time since March 16.
And how did the market react the last time the VIX pushed below 14? The answer lies in the chart below.
SPY tacked on an additional $1 before eventually faltering. In fact, over the next two months SPY lost $14, or roughly 10%.
On course, the VIX could fall to its historic low of 11 or so – a three-point drop from here.
On the other hand, a bullish move in the volatility index could realistically push the VIX all the way up to 25, a gain of roughly 80%. That may seem like an outlandish prediction. But keep in mind that when volatility expands, it happens fast. Just look at the move last March when the VIX nearly doubled in just eight weeks.
From an investing and trading perspective, this is an ideal spot to pay very close attention to the fear index.
Are we in store for another low-volatility environment like we experienced in the mid-90’s and mid-2000’s? Possibly.
But think about the current scenario in the market.
We have a current low-volume rally in the S&P that has pushed the index up against key levels, while simultaneously moving further and further into a very overbought extreme over various time frames.
In addition, the period following options expiration, particularly August expiration has been historically weak.
I am not necessarily long-term bearish, I just think we should all pay close attention to how the market reacts around these levels and not make any irrational decisions based on the recent advance. |
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| Overbought/Sold Condition Report |
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Overbought/Oversold as of August 18, 2012
• S&P 500 (SPY) – 81.3 (very overbought)
• Dow Jones (DIA) – 83.7 (very overbought)
• Russell 2000 (IWM) – 77.2 (overbought)
• NASDAQ 100 (QQQQ) – 97.8 (very overbought)
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Thank you again for being a part of the Terry's Tips newsletter. If you are interested in signing up as an Insider, visit Terry's Tips today for details.
Sincerely,
Dr. Terry Allen
Terry's Tips
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