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.

New Year’s VIX Hangover Explained

Here is one of the biggest trading anomalies on Wall Street: Since 1970, the S&P 500 delivered a year-end rally 76.1% of the time, but the VIX declined over the same period only 13.8% of the time.

Since 1970, the S&P 500 staged a year-end rally (often considered the Santa Claus Rally, comprised of the last five trading days of the old year, and first two trading days of the new year) 35 out of 46 years, or 76.1% of the time.

The average gain is around 1.5%. This rally has been reliable enough that investors view it as a foregone conclusion.

Despite the strong propensity for the S&P 500 (NYSEArca: SPY) to rally, the VIX has declined only 4 of the last 29 years.

This is one of those charming and somewhat inexplicable VIX anomalies.

We don’t need to understand every anomaly as long as we are aware of it.

The December 23 Profit Radar Report highlighted this quirk by comparing VIX and S&P 500 seasonality (see chart below) and stated:

Year-end S&P 500 seasonality is quite strong, as is VIX seasonality. This is one of those ‘charming’ VIX quirks that doesn’t make sense. Therefore, we are closing our VelocityShares Daily Inverse VIX ETN (NYSEArca: XIV) position at 34.90.”

If the VIX rises when stocks are up, imagine what happens when stocks are down. We don’t have to imagine, we just saw it.

Inverse volatility ETFs like XIV and SVXY has dropped like a rock wile the iPath S&P 500 VIX ETN (NYSEArca: VXX) soared like an eagle. Based on historical data, this would have happened anyway, even without S&P 500 selloff.

VIX seasonality is somewhat choppy until early March, so trading the VIX will take good timing.

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.

Don’t Fall for This Year-end VIX Trick

It’s the time of year when stocks are expected to rally.

S&P 500 (NYSEArca: SPY) seasonality, based on data going back to 1950, confirms the tendency to end the year on a high note.

At first glance, this looks like a good setup to short the VIX.

Three options to short the VIX are:

  • Buy VelocityShares Daily Inverse VIX ETN (NYSEArca: XIV)
  • Buy ProShares Short VIX ETF (NYSEArca: SVXY)
  • Short iPath S&P 500 VIX ETN (NYSEArca: VXX)

However, S&P 500 strength does not automatically translate into VIX weakness, especially during the final days of the year.

In fact, the VIX tends to rally in late December. The chart below shows that shorting the VIX during the ‘Santa Claus Rally’ period is not the most brilliant of ideas.

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.

VIX at 5 ½ Year Low – What Does it Mean for Stocks?

The VIX staged a historic performance over the last 16 trading days. It took 8 trading days to soar 47% and another 8 trading days to drop 43% to a 72-month low. What’s next for the VIX and what does it mean for the S&P 500?

From December 28 – January 9 the Volatility Index (VIX) dropped 43%. Such deterioration of implied volatility is unprecedented in the 20+ year history of the “Fear Index.”

On Wednesday, the VIX fell as low as 13.22, the lowest level since June 20, 2007. Extremes like this often plant the seeds for massive trade opportunities, they are music to our ears.

Is there any significance to the recent VIX behavior and its 72-month low? What does a low VIX mean for stocks?

VIX/S&P 500 in 2010

A low VIX in 2010 and 2011 always spelled trouble for stocks. On April 12, 2010 the VIX fell as low as 15.23. The S&P 500 topped on April 26 and dropped 17% thereafter.

VIX/S&P 500 in 2011

The same top and drop scenario happened in 2011. On April 20, 2011 the VIX moved as low as 14.30. The S&P 500 topped on May 2 and fell 21% thereafter.

VIX S&P 500 in 2012

In 2012 the VIX stair-stepped as low as 13.30 on August 17. The S&P didn’t top until September 14. Although the S&P corrected as much as 8.8%, the VIX barely moved higher. In fact it still traded at 13.67 on October 5.

What’s the takeaway? As the chart below illustrates, the VIX/S&P 500 correlation was a helpful timing tool in 2010 and 2011, but not in 2012. In fact, the VIX 2012 performance had little correlation to its historic seasonal pattern.

Better Use of the VIX

I’ve found it helpful to extract buy/sell signals via the VIX’s interaction with the Bollinger Band. On December 31 the VIX closed below the upper Bollinger Band.

The January 1, Profit Radar Report stated that: “This is a VIX sell signal and a buy signal for stocks.”

VIX/S&P 500 Outlook

The VIX closed near its high of the day yesterday, forming a possible reversal candle against a potentially bullish RSI divergence. The immediate down side for the VIX seems quite limited. Going long the VIX at current prices provides a much better risk/reward ratio than going short.

Trading the VIX is difficult as options suffer from time decay and futures from contango. VIX exchange traded products – like the iPath S&P 500 VIX ETN (VXX) and VelocityShares Daily Inverse VIX ETN (XIV) – provide exposure to the VIX, but suffer from the same problems as they use options and futures to replicate the VIX performance.

With or without setback, I expect the S&P 500 to labor a bit higher towards key resistance before a possible major reversal.