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.

This VIX Trick is Stumbling Investors

On August 24, the VIX briefly soared to 53.29, I was getting ready to leave for Europe that day, but saw the action on my phone and thought: “Boy, wish I had the time to figure out a good VIX short.”

I even wrote in the August 24 Profit Radar Report update that: “Today’s VIX high (53.29) will likely stand for a while. Buying XIV (inverse VIX ETN) is tempting, but the issue with XIV is that we may not have the benefit of contango right now, but the drag of backwardation.”

An explanation of contango and backwardation (along with the best seasonal VIX signal) is available here (last two paragraphs).

In short, backwardation is a condition that either increases XIV or SVXY losses or erodes XIV and SVXY gains while the VIX trades above 20 – 25.

The chart below plots the CBOE VIX against the VelocityShares Daily Inverse VIX ETN (NYSEArca: XIV). Another inverse VIX vehicle is the ProShares Short VIX ETF (NYSEArca: SVXY).

Although the VIX retreated more than 50% since August 24, XIV is up ‘only’ ~10% (SVXY is up ~8%).

Welcome to the power of backwardation.

Understanding contango and backwardation is vital for VIX investors.

Just as backwardation is hurting XIV and SVXY right now, contango will likely benefit them later on this year.

The VIX seasonality chart offers strong clues when the next good setup will be. This is the same VIX seasonality chart that triggered a buy signal in early July.

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.

3 Important Things to Know When Investing in ETFs

ETFs are cost effective, tax efficient, liquid and can be traded throughout the day (unlike mutual funds). Most investors are familiar with the appealing ETF basics, but here are a few tricks and traps the average Joe investor may not know.

ETFs (Exchange Traded Funds) have been called the best thing since sliced bread.

The ETF universe has ballooned to well over 1,300 ETFs, controlling nearly $2 trillion in assets. The $15 trillion mutual fund industry is less than thrilled about the splash ETFs made in their investment pool.

ETFs are popular for a reason, but this article addresses not only the ETF basics, it also reveals some tricks and traps the average investor may not be aware of.

ETF Basics

Know what’s under the hood: The initial success of broad market ETFs, like the SPDR S&P 500 ETF (NYSEArca: SPY), sparked much innovation and the need for additional ETF structures.

Today there are five different ETF structures, each with its own pros, cons, and tax treatment. In fact, in recognition of this diversity, what used to be called the ETF universe, has become the ETP (Exchange Traded Product) universe.

A detailed look at the different structures along with advantages and disadvantages is available here: Basic ETF Structures Explained

Diversification:  Most ETPs provide exposure to a basket of stocks or bonds. Most often that basket is linked to an index.

Some ETPs screen their holdings based on certain filters, are actively managed or designed to track the performance of commodities, currencies are other assets classes.

Cost & Tax Advantages: There are exceptions, as you would expect in any group numbering over 1,300, but ETPs in general are more cost and tax effective. The cheapest S&P 500 ETFs costs only 0.05% per year.

Liquidity: ETPs sell like stocks and can be instantly (assuming the market is open and you have a brokerage account) bought or sold with the click of a button. Mutual funds are redeemed (time delay is at least a few hours), often at a price that has yet to be determined.

ETF Tricks & Traps

Like every other investment, ETPs don’t come with a built in protection against moronic decisions.

The emergence of short, leveraged and leveraged short ETPs actually makes it easier for investors to lose (and make) money even faster. The epitome of a two-edged sword.

Due to the structure of short and leveraged ETPs, the odds of landing a profitable trade are not always 50/50.

Some leveraged (short) ETPs have a tendency to enhance returns in a down market, others in an up market. Sideways markets may deliver unpredictable returns, even returns unrelated to the underlying benchmark.

For example, the popular but notoriously declining iPath S&P 500 Short-term VIX ETN (NYSEArca: VXX) has been a trap for many investors.

The first chart below plots VXX against its benchmark, the VIX. I’ve inserted a 50-day SMA to show the basic trend. VXX has been down even though VIX has been trading predominantly sideways.

The second chart plots VelocityShares Daily Inverse VIX ETN (NYSEArca: XIV) against its benchmark, which is also the VIX.

You probably get the point. The choice of ETPs can influence the odds of winning beyond the normal odds dealt by the market.

More details about the subtle, but important idiosyncrasies of ETPs is available here: The Must Know Basics of Short & Leveraged ETFs

Know Thy ETF Universe

With over 1,300 ETPs comes the freedom of choice. The following criteria should be considered when on the prowl for the best ETP:

  • Cost
  • Trading volume
  • Performance track record
  • Structure and tax advantages/disadvantages
  • Tracking method (sampling or replication) and accuracy

ETPs also offer exposure to asset classes and currencies that, in the past, used to be off limits for the average investor. So take a stroll through the ETP universe. You may find asset class ‘galaxies’ that may harmonize with your portfolio on planet Earth.

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 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.

Record Bet: Trader Sells $18 Million in VIX Calls

Trading is tough business, but trading the VIX is even tougher, because you are betting ‘against the house’ many times. Here’s how to avoid the force that eats into your profits and make it work for you.

Based on Bloomberg data, an unknown trader sold about $18 million in VIX (Chicago Options: ^VIX) calls on Monday.

At the time of the trade execution the VIX was trading near 19. Many of the sold calls had a strike price of 22 with February expiration.

This is a gutsy trade, but is it gutsy smart or gutsy stupid?

The seller of a February 22 VIX call commits to selling the VIX at 22 on or before the third Friday of February. Obviously,  no one wants to buy the VIX at 22 as long as it trades below 22.

Therefore, the above trade will be profitable (seller gets to keep the premium) if the VIX remains below 22.

Based on the weight of evidence, this is a smart trade for the following reasons:

1. The VIX chart below (published in Sunday’s Profit Radar Report) shows overhead resistance at 18.60 and 20.30.

Sunday’s Profit Radar Report proposed that: “Resistance at 18.60 – 20.20 should cap the immediate VIX up side.”

2. The VIX often peaks before the S&P 500 bottoms, creating a positive divergence. This means that even another minor S&P 500 (NYSEArca: SPY) low may not translate into a higher VIX high.

3. Bearish VIX strategies benefit from contango.

Contango is a condition where the VIX futures (price of VIX in the future) trade at a higher price than the VIX spot price (current price). Contango is in essence a premium. The further away the expiration of the futures, the higher the premium.

Some research on the iPath S&P 500 VIX Short-term Futures ETN (NYSEArca: VXX) suggests that the cost of contango is about 0.25% – 0.45% per day. Contango usually occurs when the VIX trades below 25.

The opposite is true as well. Contango erodes gains of bullish VIX strategies.

To illustrate: For my personal account (more or less as an experiment) I bought a March 12 VIX call, which gave me the right to buy the VIX at 12. I bought the call on January 13 for $3.20 when the VIX traded at 11.84, and sold it on January 27 when the VIX traded at 18.40.

The VIX surged 55%, but my VIX call, a highly leveraged vehicle, gained ‘only’ 40%.

The iPath S&P 500 VIX ETN (NYSEArca: VXX) gained a maximum of 20% over the same period of time, and the 2x leveraged VelocityShares Daily 2x VIX ETN (NYSEArca: TVIX) returned no more than 37%.

Keep in mind that this was an extremely well timed VIX trade. If you get the timing wrong, contango will eat into profits and emphasize losses.

The VelocityShares Daily Inverse VIX ETN (NYSEArca: XIV), an inverse VIX ETN, tends to benefit from contango when the VIX is trending lower. XIV somewhat mirrors the call selling strategy explained above.

Based on S&P 500 analysis, the VIX is in for a rocky ride … and many profit opportunities. Here are three reasons why:

Watch for Bounce! But 3 Reasons Why a Longer Correction is Likely

Simon Maierhofer is the publisher of the Profit Radar ReportThe Profit Radar Report presents complex market analysis (stocks, 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.