By Chris Kidd, Senior Option Strategist at Wall St. Renegade
As a professional investor and an options trader, I keep a close eye on the markets, look for patterns, and always look for what’s coming next. While it is impossible to be right all the time, it is very possible to see indicators that can give you an idea of what should happen. We are at all-time highs in the stock market, but I believe the waters are about to get rough. That does not mean I think we are going into a bear market necessarily, but I expect volatility to pick up.
The CBOE (Chicago Board of Options Exchange) Volatility Index ($VIX) just hit a 52 week low (11.68), and is not far off its 5 year low (11.05). You have to go back to January 2007 to find the last time the VIX was under 11. This volatility index is sometimes know as a fear indicator. The more fear that comes into the market, the higher the VIX goes. On the reverse side, the more complacency that is in the market, the lower it VIX goes. Investors have now become very complacent (which is a setup for a selloff).
This is why I am buying VIX call options, betting on a jump in volatility. I believe we are in danger of an ugly selloff in the stock market. Whether things get ugly, or we just get a little correction, I expect things to get more volatile. I have a position in SDS, which is a double short ETF against the S&P 500, as a way to hedge my portfolio and make a smooth transition if we get a violent correction or even a bear market. The VIX can be a hedge as well, but in this case I am buying VIX call options in an attempt to profit from a spike in volatility that I believe is coming very soon.
Over the past three years, the VIX has dropped below 12 seven times, and all of those cases were in the last 16 months. Each time the VIX spiked over 16 within about a month’s time, the longest wait being 35 days. Ten days ago the VIX dipped below 12, then again today, so we are ten days into this cycle without a spike yet. Based on the recent patterns I would assume we will see a spike above 16 within the next 20 days. There’s a saying in the market: “The trend is your friend.” Until this trend changes I intend to buy volatility anytime the VIX drops below 12.
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