The Option Pit VIX Light Is Green: Volatility Is Going To Go Up.

Hey Traders,

I have to admit it: I was wrong.

I thought we would see a huge up day on Friday…

It is the pattern we had seen in the stock market for the prior five expiration cycles.

But this time, something changed …

Is it China? Yes.

Is it COVID, too? Probably not.

However, there is certainly a government story around this market, along with China, and the Fed.

So what IS going on? And what is the right trade?

Backwards VIX Curve

Like I talked about yesterday, the VIX curve is now backward, meaning that the VIX is trading over a WHOLE lot of VIX futures:

Briefly on Monday, the VIX was not just backward from cash to future but specifically was showing me the type of backwardation that REALLY scares me.

We had the VIX spot price over October futures, October futures over November, and November futures over December futures …

When that happens, and we hold it, all hell can break loose.

But we did see futures relax a touch in the last hour of trading as the S&P 500 rallied 50 points.

So, is this over now?

Is the fear gone?

Not by a long shot.

I have seen this story before, and it typically lasts a few weeks at minimum.

Here is how it usually plays out:

First, there is a big sell off, typically lasting a few days.

Next, there is a rally that recovers some of the losses.

Finally, we sell off again, with a lower high in the VIX.

FINALLY, FINALLY, the S&P 500 begins a bull run …

Unless the selling builds momentum, which is a real possibility I’ll discuss tomorrow.

But let’s talk about how to play the ‘typical’ scenario above. 

If you want to short volatility, the key is to wait until that VIX hits the lower high, or wait until the whole VIX futures curve re-enters a contango.

Otherwise, stay away.

In the meantime, this is a short-term trader’s dream.

Day trade short vol and long vol, while holding an overall long volatility position.

This can be done by using ProShares Ultra VIX Short Term Futures ETF (Ticker: UVXY) as a trade vehicle, and then a combo of VIX and iPath S&P 500 VIX Short-Term Futures ETN (Ticker: VXX) to handle the rest.

Right now, I am mostly using VXX to hedge. The weekly positions allow me to move positions around, so I’m able to stay nimble.

I would love to say the same thing about weekly VIX options, but I can’t. They are too illiquid.

Meanwhile I might hold an October VIX long spread …

I know it sounds like a lot, but it’s not as much as you think. It’s just a combination of short-term momentum trades, which are paying for a slightly longer-term hedge.

Playing long volatility requires this kind of trading sometimes … because frankly, there is too much money to be made!

Your Only Option,

Mark Sebastian