The Spectacular VIX Tailwind Trade

This is a reprint of the August 24 Special Profit Radar Report:

The CBOE Volatility Index (VIX) is a popular index, but in itself is not investable. You can’t just go out and buy the VIX. The same is true for the S&P 500 or any other index.

But investment vehicles like the SPDR S&P 500 ETF, which aims to replicate the performance of the S&P 500 index, make it possible to invest in indexes.

Duplicating the performance of the S&P 500, however, is much easier than creating a vehicle that mimics the VIX. Fund managers simply purchase the stocks that make up the S&P 500 to create an S&P 500-like product.

It doesn’t work like this for the VIX. Here’s why:

There is no ‘VIX stock.’ The only way to invest in the VIX is via futures or options, which are complex financial instruments. ETFs, ETNs or other ETP’s use futures or options to attain ‘VIX-like’ performance. VIX futures and options generally suffer from some sort of time decay.

Explained: Contango

The VIX quoted in-day-to-day life is the CBOE Volatility Index (VIX) spot price (today’s VIX price). However, the futures used to create ETPs like the iPath S&P 500 VIX Short-Term Futures ETN (VXX) are based on the future VIX price, which is almost always more expensive than the spot price. Over time the more expensive VIX futures decline in value, eventually converging with the spot price at expiration.

Figure 1 compares the current spot price with various futures prices. The difference between the spot price (12.20) and the September futures (13.45) is 9.84%. In other words, it will take a 9.84% move in the VIX to neutralize the time decay between the spot and September futures price.

As time goes by, ETF providers are forced to continuously replace expiring futures with new (more expensive) futures (this process is called ‘rolling over’). The further away the futures expiration date, the bigger the time premium. This time premium and resulting value decay is called contango.

Contango generally exists when the VIX is flat or trending lower. Even gradual increases when the VIX is below 20 tend to occur in an environment of contango.

Backwardation (figure 2) is the opposite of contango. Backwardation generally appears only during times of panic and significant VIX spikes above 20.

To sum up, contango erodes investors’ returns during periods of a flat or falling VIX.

How to Profit from Contango

We don’t expect a major stock market top yet, therefore the period of low volatility is likely to continue (or resume after the seasonal October VIX high).

Is it possible to use contango in our favor?

Figure 3 plots the VIX against the VelocityShares Daily Inverse VIX Short-Term ETN (XIV), and reveals a very simple truth: XIV has risen much more than the VIX has fallen.

Figure 4 shows the cumulative gain/loss from January 3, 2011 to August 15, 2014. The VIX lost 25%. XIV gained 242%. XIV returned 217% more than the inverse VIX.

XIV’s objective (and the objective of every other inverse or leveraged ETP) is to replicate the daily (not long-term) inverse performance of the VIX, but regardless, this kind of excess return is worth exploring.

Here is a more detailed breakdown of XIV’s excess return.

XIV is an inverse VIX ETN. For an apples to apples comparison, we are comparing XIV with a simple inverse VIX.

Of the 911 trading days from January 3, 2011 to August 15, 2014, the inverse VIX had 484 up days and 427 down days. The inverse VIX had 1.13x more up than down days.

The average gain of 484 up days was 4.55%. The average loss of 427 down days was 5.85%. The average loss was 1.28x greater than the average gain.

Of the 911 trading days from January 3, 2011 to August 15, 2014, XIV had 522 up days and 389 down days. XIV had 1.34x more up than down days.

The average gain of 522 up days was 2.63%. The average loss of 389 down days was 3.18%. The average loss was 1.21x greater than the average gain (see figures 5 and 6).

Summary

Since 2011, XIV outperformed the inverse VIX by 217% (0.24% per day). Although there are other factors at work, the excess return of 0.24% per day is largely attributed to the effect of contango.

Contango does not guarantee a profitable trade or protect against losses. From July 7 – November 21, 2011 XIV lost 75%. There are also times where the VIX moves lower and XIV loses value (i.e. August 18 – 21, 2014).

Over time however, contango significantly enhances the odds of a successful XIV trade, especially when XIV is purchased during times of VIX spikes.

A list of VIX Exchange Traded Products that benefit from contango, a updated VIX seasonality chart, and actual buy/sell signals are available via the Profit Radar Report.

Simon Maierhofer is the founder of iSPYETF and the publisher of the Profit Radar Report. Barron’s rated iSPYETF as a “trader with a good track record” (click here for Barron’s profile of the Profit Radar Report). The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013, 17.59% in 2014, and 24.52% in 2015.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

3 Tricks for Trading the VIX

More than any other asset class, the Volatility Index (VIX) is subject to distinct patterns or biases that either help or hurt investors.

Being aware of the 3 VIX tricks discussed below will significantly increase the odds of a winning trade.

1) VIX Seasonality

I invite you to inspect the VIX seasonality chart below. Based on 25 years of trading history, there are two important seasonal turning points: July 2 and October 9.

The VIX has a strong tendency to move higher starting in early July (green arrow), and to move lower after early October (red arrow).

For example, the June 23, 2015 Profit Radar Report stated that: “The VIX closed below the lower Bollinger Band for the first time since June 6, 2014. A close back above the lower Bollinger Band will be a buy signal. VIX seasonality is soon turning higher for the best VIX seasonal signal of the year.”

Shortly thereafter the VIX rallied from 12 to 20 and eventually to 50.

Due to the massive summer spike, this year’s October sell signal was shifted.

Nevertheless, the November spike (last chart, red arrow) offered a good setup to short the VIX, as the November 16 Profit Radar Report brought out: “The VIX closed below the upper Bollinger Band, which is a sell signal.”

The October sell signal is particularly intriguing because it gets magnified by a major bias of inverse VIX ETPs (Exchange Traded Products, such as ETFs and ETNs). This bias can be worth 0.25% per day for weeks.

2) Inverse VIX Bias

ETPs like the iPath S&P 500 VIX ETN (VXX) or the VelocityShares Daily Inverse VIX ETN (XIV) use futures (or options) to replicate VIX-related performance.

The performance of futures-based ETPs is typically cannibalized by a condition called contango. However, a bet on lower VIX prices allows investors to turn this generally harmful condition into a superbly beneficial tail wind.

Below is an admittedly dry explanation of contango, but I think you will find it well worth your time (no pain, no gain).

The VIX quoted in-day-to-day life is the CBOE Volatility Index (VIX) spot price (today’s VIX price). However, the futures used to create VIX ETPs are based on the future VIX price, which is almost always more expensive than the spot price. Over time the more expensive VIX futures decline in value, eventually converging with the spot price at expiration.

As time goes by, ETF providers are forced to continuously replace expiring futures with new (more expensive) futures (this process is called ‘rolling over’). The further away the futures expiration date, the bigger the time premium. This time premium and resulting value decay is called contango.

Contango generally exists when the VIX is trading below 20. The opposite of contango – backwardation, when future VIX prices are lower than at present – generally appears when the VIX trades above 20.

I wrote a detailed report on how to actually make contango work for investors back on August 24, 2014 (entire report available to subscribers of the Profit Radar Report).

Below are some of the findings and charts shared in this report:

The two biggest beneficiaries of the ‘reverse contango’ benefit are the VelocityShares Daily Short-term VIX ETN (NYSEArca: XIV) and ProShares Short VIX Futures ETF (NYSEArca: SVXY).

The chart below compares the VIX with its inverse counter part, XIV. Shown is the cumulative percentage return from January 3, 2011 to August 15, 2014.

It quickly becomes obvious that XIV has risen much more than the VIX has fallen.

XIV is an inverse VIX ETN. For an apples to apples analysis of the excess return, here is a comparison between XIV and an inverse VIX (the VIX inversed).

  • Of the 911 trading days from January 3, 2011 to August 15, 2014, the inverse VIX had 484 up days and 427 down days. The inverse VIX had 1.13x more up than down days.
  • The average gain of 484 up days was 4.55%. The average loss of 427 down days was 5.85%. The average loss was 1.28x greater than the average gain.
  • Of the 911 trading days from January 3, 2011 to August 15, 2014, XIV had 522 up days and 389 down days. XIV had 1.34x more up than down days.
  • The average gain of 522 up days was 2.63%. The average loss of 389 down days was 3.18%. The average loss was 1.21x greater than the average gain (see figures 5 and 6).
  • From January 3, 2011 to August 15, 2014, XIV outperformed the inverse VIX by 217% (0.24% per day).

Obviously the reverse contango benefit doesn’t guarantee a profitable trade, but on average XIV provides a ‘daily edge’ of 0.25%. At times, the edge is much more pronounced, such as on November 30, 2015, when the VIX rose 6.68%, but XIV gained 0.74% (when it should have lost some 6.68%).

VIX Technical Analysis

As you may have noticed from the two above Profit Radar Report quotes, the Bollinger Bands can be very helpful when it comes to spotting buy/sell signals, especially when they occur near the two major seasonal turning points (see chart below).

Simple support/resistance levels and trend channels can also be of help. The green/red arrows below highlight the buy/sell signal given by the Profit Radar Report.

Summary

Seasonality and technical analysis triggered a VIX sell signal on November 16.

The sell signal remains active and the ‘contango tailwind’ should by overall positive for XIV until late December.

However, for the first time since the start of the 2009 bull market, we are seeing signs of distribution (liquidity is drying up). This could become an issue when the next (bullish) VIX turning point arrives.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013 and 17.59% in 2014.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

Crude Oil Analysis Update

It’s been a while since the last free crude oil analysis (March 23: Next? A Crude Awakening for Oil Bears?).

The March 23 article noted that: “Commercial traders are starting to prepare themselves for further gains. Oil seasonality also suggests higher prices. Probably more important is a trend line that’s been important for oil prices for nearly two decades (this proprietary trend line and detailed oil seasonality chart reserved for subscribers of the Profit Radar Report). A move above this trend line is likely to trigger a rally.”

This important trend line is now in the rear view mirror, and I’m able to disclose it without conflict to my paying subscribers.

The green bold line in the crude oil futures chart below represents this trend line. It originates all the way back in 1998.

Since overcoming the bold green trend line, oil prices rallied as much as 33%.

Below is a summary of observations made in the Profit Radar Report since March:

March 29: “For aggressive traders, playing the long side (buy on dips) should ultimately prove profitable.”

April 8: “A close above 54.30 should bring more follow through gains.”

 

April 15: “Crude oil broke above 54 today. The breakout has legs as long as it stays above 54.”

May 6: “Oil prices are now gnawing on the resistance zone around 60. Yesterday’s red candle high may cause a pause. Next support is around 58.50, which could be an opportunity to buy.

Oil is trading around 58.50 right now. Based on seasonality, price may test support at 56 or 54.30 between now and mid-June (proprietary oil seasonality chart available to Profit Radar Report subscribers).

Overall, I anticipate oil prices to move higher as long as support at 54.30 holds.

Based on seasonality, buying oil ETFs like the United States Oil Fund (NYSEArca: USO) or iPath Crude Oil ETN (NYSEArca: OIL) before mid-June and/or around 54 – 56 (based on crude oil prices) is a trade worth watching.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013 and 17.59% in 2014.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

 

Key Commodity Index at Major Inflection Point May Provide Clues for Oil

As MVP of the commodity sector, oil is usually in the spotlight (especially after a dizzying 60% drop) while most of the other commodities operate in the shadow.

The Reuters/Jefferies CRB Commodity Index, the Granddaddy of broad commodity indexes, sports an interesting chart right now.

The index has reached the lower end of a trend channel that’s defined a multi-year down trend.

Is that a buying opportunity? Is oil near a low?

First we should look at the composition of the Reuters/Jefferies CRB Commodity Index.

In 2005, the index was revised from an equal weighted to a 4-tiered grouping system, designed to reflect the significance of each commodity. Here is the group weighting:

  • Agriculture: 41%
  • Energy: 39%
  • Base/Industrial metals: 13%
  • Precious metals: 7%

Crude oil makes up 23%. The next biggest components are gold, natural gas, corn, soybeans, aluminum, copper and live cattle with 6% each. Silver accounts for only 1%.

Since oil is the heavy weight of the Reuters/Jefferies CRB Commodity Index, trend channel support should be watched carefully for anyone fishing for an oil bottom.

Under normal circumstances this would be a low-risk opportunity to buy the Reuters/Jefferies CRB Commodity Index (trend channel could be used to manage risk).

However, there is no Reuters/Jefferies CRB Commodity ETF.

Broad based commodity ETFs include the PowerShares DB Commodity Tracking ETF (NYSEArca: DBC) and iShares GSCI Commodity ETN (NYSEArca: GSG).

DBC has a strong correlation to the Reuters/Jefferies CRB Commodity Index, but the actual chart paints a different story.

DBC already dropped below trend channel support and is near its all-time low. Aside from a Fibonacci projection level at 14.13, there is no technical chart support.

This makes it hard to manage risk effectively. Traders looking to bottom pick should probably use the Reuters/Jefferies CRB Commodity Index trend channel as stop-loss for any long positions. Oil ETFs include the United States Oil ETF (NYSEArca: USO) and iPath Oil ETN (NYSEArca: OIL).

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

Initial 2015 S&P 500 Forecast

The S&P 500 is starting 2015 off with a thud, down 3% in two days. One exotic indicator featured in the December 21 Profit Radar Report warned of a very weak beginning of the year. Here’s a closer look at this indicator.

As my regular readers and subscribers to the Profit Radar Report know, I follow a ton of indicators.

Most of those indicators fall into one of three category buckets: Technicals, sentiment, seasonality.

In the December 21 Profit Radar Report I offered two projections based on Elliott Wave Theory. EWT is one of the more exotic technical indicators, but at times it offers insight no other type of analysis can provide.

The December 21 Profit Radar Report stated that: “Stocks may hit an inflection point once the S&P 500 and Russell 2000 record new all-time highs. About 25% of funds allocated for trading equities are tied up in the iShares Russell 2000 ETF (NYSEArca: IWM, Materials Select Sector SPDR ETF (NYSEArca: XLB) and VelocityShares Daily Inverse VIX ETN (NYSEArca: VXX). We’ll keep this allocation until we see new all-time highs. Thereafter, we will re-evaluate if further gains or a correction is more likely.”

Below is the chart with the two projections featured in the December 21 Profit Radar Report.

We sold XIV on December 23 for a profit.

By December 30, the S&P 500 and Russell 2000 delivered new all-time highs and we closed our XLB and IWM positions with gains, because the odds started to favor the more bearish projection.

Over the past two years corrections have generally been shallow, and it remains to be seen whether the S&P 500 (NYSEArca: SPY) will fall as low as projected in the chart, but for now we are glad to be out of stocks. Yesterday’s Profit Radar Report pegged the initial S&P down side target at 2,016.

A detailed 2015 S&P 500 forecast will be available (to subscribers of the Profit Radar Report) soon.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

Basic ETF (or ETP) Structures Explained

Much to the dismay of many mutual funds, ETFs have taken the financial world by storm. In recognition of the incredible variety available, ETFs are now considered Exchange Traded Products (ETP). Here’s a list of them along with advantages and disadvantages.

There are more than 1,300 ETFs with nearly $2 trillion in assets.

But not every ETF (Exchange Traded Fund) is created equal. In fact, the term Exchange Traded Products (ETPs) better describes what used to be called the ETF universe.

There are five different ETP structures. Although the difference in ETP structures may be subtle, they can affect overall returns, tax treatment and credit risk.

Here is a cheat sheet of the five ETP structures along with advantages and disadvantages:

Open-end funds

The vast majority of ETFs are structured as open-end funds, which is one of two types of ETF registered investment companies regulated under the 1940 Act. The open-end structure is generally used by ETFs whose primary objective is to provide exposure to stock and bond asset classes.

Dividends and interest received by an open-end ETF can be immediately reinvested, and derivatives, portfolio sampling, and securities lending can be utilized in the portfolio. Open-end ETFs that meet certain Internal Revenue Service standards are treated for tax purposes as pass-through entities (known as regulated investment companies), with income and capital gains distributed to shareholders and taxed at the shareholder level.

Advantages

  • Investors receive protections under the 1940 Act, as well as the 1933 and 1934 Acts.
  • Funds avoid cash drag through immediate reinvestment of dividends.
  • Funds can use derivatives, sample an index, and engage in securities lending.
  • Investors can access nearly any equity or fixed income sector or subsector.

Disadvantage

  • Funds have a limited ability to access alternative asset classes such as commodities or currencies.

Unit investment trusts (UITs)

A UIT is an investment company that holds a generally static investment portfolio and is used by a small number of ETFs that track broad asset classes. With no boards of directors or investment advisors managing the portfolio, UITs have less investment flexibility than open-end ETFs. For example, UITs do not reinvest dividends and instead hold them until they are paid to shareholders, usually quarterly. During rising markets, this can create a disadvantage known as cash drag.

In addition, UITs are not permitted to lend securities in the portfolios or use derivatives, and they must fully replicate the indexes they track. However, like an open-end fund, UITs are registered investment companies regulated under the 1940 Act and therefore offer the same level of investor protections as open-end funds. UIT ETFs that meet certain Internal Revenue Service standards are treated for tax purposes as pass-through entities (known as regulated investment companies), with income and capital gains distributed to shareholders and taxed at the shareholder level.

Advantages

  • Investors receive protections under the 1940 Act, as well as the 1933 and 1934 Acts.
  • A UIT is highly transparent because it fully replicates its underlying index.
  • A UIT has no investment manager to pay, which helps keep costs low.

Disadvantages

  • Since a UIT has no investment advisor, it is less flexible than open-end funds. (For example, it cannot use derivatives or lend securities.)
  • A UIT has a limited ability to access alternative asset classes such as commodities or currencies.
  • There is potential for higher tracking error due to cash drag.

Grantor Trusts

Grantor trusts are typically used by ETFs that invest solely in physical commodities or currencies. Grantor trusts are required to hold a fixed portfolio, as opposed to a variable one, making the structure ideally suited for physical commodities and currencies.

Because the nature of the underlying investments prevents grantor trusts from being classified as investment companies under the 1940 Act, grantor trust ETFs are regulated only by the 1933 and 1934 Acts. Therefore, while grantor trust ETFs must disclose regular financial information, they provide none of the additional investor protections laid out in the 1940 Act. Grantor trust ETFs also do not qualify for regulation by the Commodity Futures Trading Commission (CFTC), unlike partnership ETFs (described below).

ETFs that use the grantor trust structure consider investors direct shareholders in the underlying basket of investments. As such, investors are taxed as if they directly owned the underlying assets.

Advantages

  • Grantor trust ETFs are highly transparent because of the simple, fixed nature of the portfolio.
  • They have the ability to invest in alternative investments such as commodities and currencies.

Disadvantage

  • They are not regulated by the 1940 Act or the CFTC.

Exchange-traded notes (ETNs)

ETNs are issued as prepaid forward contracts that, like a bond, contractually promise to pay a specified sum—in this case, the return of a given index (minus the issuer’s expenses). ETNs are different from other ETF structures because they don’t hold any underlying assets. Instead, they represent a promise by the issuer (usually a bank) to pay a return. Investors in ETNs become unsecured creditors of the issuing bank and therefore need to take into account an additional risk—credit risk—when they are considering the purchase of an ETN.

ETNs have a preset maturity date, and they usually do not pay out an annual coupon or dividend. They are also frequently created for niche markets, sectors, or strategies, including commodities, currencies, and certain emerging markets. Since ETNs are simply a promise to pay a specified return, tracking error is eliminated once costs are taken into account.

ETNs are debt instruments, not investment companies. They are not regulated under the 1940 Act and lack many of the investor protections provided under that act’s framework.

Under current tax law, ETNs typically enjoy favorable tax treatment as prepaid forward contracts. Any accrued interest or dividends, and any appreciation in the value of the index, are generally rolled into the value of the ETN, so investors typically don’t incur taxes on them until the time of sale. However, it’s important to know your client’s tax bracket and investment time horizon, especially in light of some of the uncertainties surrounding the future taxation of ETNs.

Advantages

  • ETNs provide access to niche markets that could be difficult to track with a traditional 1940 Act ETF structure.
  • Tracking error is eliminated after factoring in costs. There is the potential for favorable tax treatment.

Disadvantages

  • There is the potential for significant credit risk.
  • There is the potential for concentration risk since ETNs tend to invest in very narrow market segments.
  • Investors in ETNs receive no protections under the 1940 Act.

Partnerships

Among the least common types of ETFs, partnership ETFs are unincorporated business entities—such as a statutory trusts or limited partnerships—that elect to be taxed as a partnership. Partnership ETFs are considered publicly traded partnerships because they trade on a stock exchange. They generally are treated as partnerships for tax purposes, which avoids double taxation at both the entity and the investor level. The income and realized gains and losses from a partnership ETF flow through directly to investors, who then pay taxes on their share. However, depending on what they invest in, partnership ETFs could be taxed as corporations.

Partnership ETFs can accommodate many different types of investments, including futures that provide exposure to certain types of commodities that are hard to store physically. For example, while grantor trust ETFs can be used to invest in gold or silver (commodities that don’t deteriorate over time and can be stored at relatively low cost), partnership ETFs generally track commodities such as natural gas and oil (which are difficult to store and lose their value over time). So instead of holding these items physically, partnership ETFs access these products through the futures market.

Partnership ETFs are usually regulated as commodity pools by the CFTC. While regulations by the CFTC include disclosure and reporting requirements, they are not as stringent as those required by the Securities and Exchange Commission under the 1940 Act.

Advantages

  • Partnership ETFs provide access to a broader range of investments beyond equities and fixed income.
  • Commodity-based futures ETFs are regulated by the CFTC and the National Futures Association and must comply with the Commodity Exchange Act.

Disadvantages

  • Investors in partnership ETFs must file a complicated Schedule K-1 tax form each year.
  • Investors in partnership ETFs receive no protections under the 1940 Act.

Information courtesy of the Vanguard Group.

Simon Maierhofer is the publisher of the Profit Radar ReportThe Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF to get actionable ETF trade ideas delivered for free.

10 Hottest ETFs For December

Hot or not? How can you buy ‘hot’ ETFs without ending up with a hot potato? Obviously there’s no foolproof way to eliminate losers before they spoil your portfolio, but here is a list of the 10 hottest ETF screened according to ‘hot potato risk.’

How can you buy a hot ETF without ending up with a hot potato?

Although there’s no foolproof protection (don’t shoot the messenger) against “today it’s hot, tomorrow it’s not” portfolio decisions, there are things that can be done to separate the wheat from the chaff.

Here’s a look at some of the hottest Exchange Traded Products (ETPs; include ETFs and ETNs) around. The list at the bottom of this article shows which ETPs have the potential to remain (or turn) hot throughout December.

VelocityShares Daily Inverse VIX Short-term ETN (XIV)

This is the best performing non-leveraged ETP over the past three years, up 546.23%. XIV is the inverse counterpart of the popular iPath S&P 500 VIX Futures ETN (NYSEArca: VXX).

Unlike VXX, XIV actually benefits from contango at times of low volatility. Over time this benefit of contango averages about 0.25% per day (click here for an explanation of contango).

VIX seasonality is pointing lower for another few weeks, but things may get a bit rocky for the VIX and XIV thereafter. XIV is a quick mover, but buying XIV at times of significant VIX spikes tends to deliver nice returns.

iShares Russell 2000 ETF (IWM)

IWM is by no means a top performer going into December, however, starting in mid-December, small cap stocks often outperform large cap stocks.

A low-risk strategy to profit from this potential small cap outperformance is this pair trade. Buy IWM and short the S&P 500 ETF (SPY).

VelocityShares 3x Inverse Crude Oil ETN (DWTI)

DWTI is the hottest ETP over the past four weeks, up 31.53%. Crude oil prices just sliced to the lowest level since May 2010.

Although trade is stretched to the down side, and – like a rubber band – oil may rally at any given time, the crude oil chart does not yet display the classic signs of a major low.

It appears that new lows are still ahead, but milking DWTI at this stage may be a bit greedy. Hey, but there’s nothing wrong with enjoying the trip to the pump for a change.

ProShares UltraShort Silver (ZSL) – iShares Silver Trust (SLV)

The 2x leveraged short silver ETF (ZSL) is up 32.20% over the past three months, but ZSL has ‘hot potato risk’ written all over it.

Silver futures painted a massive green reversal candle on Monday. Now may be the time to trade in ZSL for the iShares Silver Trust (NYSEArca: SLV).

iShares Nasdaq Biotechnology ETF (IBB)

Biotechnology is the best performing sector year to date, up 31.42%. Investing in biotech is always a bit of a gamble, but the trend for IBB is up as long as support at 300 and 275-280 holds.

Coffee ETFs

A look at coffee prices may explain why your Starbucks venti, half caff, one-pump, skinny, soy latte with extra whipped cream costs more than 5 bugs.

It also explains why two coffee ETPs made it into this year’s list of top 5 hottest non-leveraged ETFs:

  • iPath DJ-UBS Coffee ETN (NYSEArca: JO) +61.34%
  • iPath Pure Beta Coffee ETN (CAFE) +56.84%

Will JO and CAFE continue to caffeinate portfolios or is there risk of a sugar crash? A combination of chart analysis and cycles suggests this low-risk strategy: Buy JO and/or CAFE on a 10% pullback.

‘Big Picture’ ETFs

Drum roll please! Here are the top three ETFs of the past 5 years:

  • ProShares Ultra Consumer Services ETF (NYSEArca: UCC) +493.70%
  • Direxion Daily MidCap Bull 3x ETF (NYSEArca: MIDU) +458.23%
  • ProShares UltraPro S&P 500 ETF (NYSEArca: UPRO) +455.29%

Nine of the top 10 best performing ETFs are leveraged U.S. equity ETFs.

This raises the mother of all ‘hot or not’ questions: Are U.S. stocks a hot potato? Is this massive bull market (almost) over?

Ask ten different analysts and you’ll probably get ten different answers. When analyzing stocks, I find it best to leave my ego at home and simply look at the facts.

Obviously different analysts look at different facts (many of which are just biases). I like to look at the indicator that correctly foretold the 1987, 2000 and 2007 tops. The same indicator continued to point higher from 2009 until today (click here for more details on this indicator I call ‘secret sauce‘).

In a nutshell, the stock market is showing signs of aging, but a major S&P 500 or Dow Jones top appears still months away. There’s still time to hold some potatoes before they get too hot. However, most investors should consider using non-leveraged vehicles like the S&P 500 SPDR (NYSEArca: SPY) and Dow Jones Diamond (NYSEArca: DIA).

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

Up Next: Quantitative EATING Program – Chocolate Shortage ETFs

Here’s a matter of national importance. Chocolate prices are on the rise. The world’s largest chocolate manufacturers warn that the world is running out of cocoa. Is it really true, or just hype?

Here is an issue of national importance: A chocolate shortage.

“The world could be heading toward a global shortage of chocolate” – Time
“Cocoa shortage worries chocolate lovers” – NBC News
“Worlds largest chocolate manufacturer warns of potential cocoa shortage” – The Independent
“Is a chocolate shortage on the way” – USA Today

The price of cocoa soared 67% from March 2013 to September 2014.

Mars, the makers of M&M’s and Snickers, announced in July it would raise prices by an average of 7%.

However, since September, cocoa prices have fallen 17%.

Is this drop an opportunity to invest in cocoa or is the cocoa shortage all hype?

There are legitimate reasons for cocoa demand to outstrip supply:

  • Dry weather in West Africa. Africa is responsible for 70% of the world’s production
  • Deadly fungi like frosty pod and witches’ broom
  • A growing taste for chocolate by emerging countries
  • Ebola

We’ve seen a number of commodity ‘shortages’ in recent years. There was corn (ethanol as alternative fuel source) and wheat. Both are trading at or near multi-year lows today.

Based on the current media hype, I wouldn’t be surprised to see a bit more cocoa weakness.

The chart says that cocoa prices need to exceed 2,845 (that’s $2,845 a ton) and the descending red trend line to break the most recent down trend.

There are two cocoa ETF/ETNs:

  • iPath Dow Jones-AIG Cocoa Total Return Sub-Index ETF (NYSEArca: NIB)
  • iPath Pure Beta Cocoa (NYSEArca: CHOC)

Perhaps the Federal Reserve will unleash a quantitative eating program to increase liquidity. After all, Wall Street is a big consumer of cocoa, especially around the holidays.

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

The Only Free and Updated VIX Seasonality Chart

The VIX is trading near 7-year lows and two VIX ETFs are at all-time lows. Many are itching to buy the VIX and while such a trade may well be profitable, VIX seasonality provides another layer of information for a low-risk trade.

When is the best time to buy or sell the VIX or VIX ETFs/ETNs?

There are multiple ways to find decent entry points. The effectiveness of every single one of them can be enhanced by VIX seasonality.

Consider seasonality another layer of tradable information, just as you may use a mobile weather app to crosscheck what the meteorologist says on local TV.

The VIX seasonality chart below is based on daily VIX data from 1990 – 2013 and was featured in the May 21 Profit Radar Report (Profit Radar Report subscribers get complimentary access to carefully crafted seasonality charts for the S&P 500, Apple, gold and VIX).

A major seasonal VIX low is usually due towards the beginning of July. Major tops tend to form in October.

Currently the VIX is flirting with a 7-year low. The iPath S&P 500 VIX ETN (NYSEArca: VXX) and VelocityShares 2x VIX ETN just slid to (another) all-time low.

Based on the VIX’s depressed level and spread between current trade and the 50-day and 200-day SMA, it’s almost certain (based on historic precedences) that VIX will climb towards 15 sometime before September.

It is tempting to buy the VIX at current levels (someone actually bought $13 million worth of VIX calls around 12, more below). Is this a good idea?

The VIX is trading just around support at 12 and a number of indicators suggest a S&P 500 correction. Lower S&P 500 (NYSEArca: SPY) generally translates into higher VIX.

However, the VIX seasonality chart cautions that we may see even lower VIX prices in early July. This doesn’t mean the VIX can’t rally now (based on some indicators it should rally), but seasonality cautions that any rally may be muted and/or reversed.

Odds of a successful trade increase if we get another chance to buy the VIX at depressed levels in a month or so.

Regardless of seasonality, one trader decided now is the time to load up on VIX calls, $13 million worth to be exact.

Seasonality does not yet support the bullish bet, but there are three other reasons suggesting some sleepless nights for the $13 million trader. More details here:

Record Gamble: Trader Spends $13 Million on Bullish VIX Bet

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

Contrarian Signal? Traders are Record Short the VIX

The VIX has been bouncing up and down like a frog on a trampoline. Big moves can translate into nice profits, and that’s exactly what VIX traders are hoping for. A record amount of VIX traders own puts, betting on a lower VIX. A mistake?

The VIX  is bouncing up and down like a frog on a trampoline. An 81% jump from January 15 to February 3 was followed by a 32% drop since.

Those kinds of moves get traders excited, and excited they are.

According to Bloomberg data, ownership of VIX puts has soared to a record all-time high of 3.2 million on February 6.

Assets in the VelocityShares Daily Inverse VIX ETN (NYSEArca: XIV), an ETN that profits from falling VIX prices, doubled over the past two weeks.

For the first time in history, the XIV ETN has more assets than the popular iPath S&P 500 VIX ETN (NYSEArca: VXX).

It appears that traders expect Janet Yellen to soothe the VIX lower and tickle the S&P 500 (SNP: ^GSPC), which moves in the opposite direction of the VIX 80% of the time, higher.

The chart below may explain why traders are VIX bears. 21 – 23 has been formidable resistance for over 18 months (for more details see article below).

The market likes to surprise as many people as possible, and although the strong bearish conviction of VIX traders (bullish for S&P 500) may well be a contrarian signal, similarly lopsided bearish VIX bets in the past ended up profitable more often than not.

If the latest correction is just another 2013-style correction, it likely ended last week (see correlation between VIX highs and S&P 500 lows).

However, any ‘Yellen rally’ would have to overcome and sustain trade above resistance at 1,810 – 1,815, which is comprised of the 20-day SMA, 50-day SMA, and prior high/low resistance.

In addition to the record VIX bets mentioned above, we spotted a record $18 million single bet.

Here’s the bet and why it was a smart move: Record Bet: Traders Sells $18 Million in VIX Calls

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (S&P 500, Dow Jones, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. All Profit Radar Report recommendations resulted in a 59.51% net gain in 2013.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.