The VIX Option Pit Traffic Light Is Red, and Volatility Is Likely to Drop.
Hey Traders,
On Friday afternoon Barclays announced the big news volatility traders all over were waiting for …
VXX is going to have a 4-for-1 reverse split on Friday, April 23.
What That Means
If you own 100 shares of VXX on April 22 at $9 per share …
On Friday morning, you’ll wake up with 25 shares of VXX — at $36 per share.
You might wonder why that’s a big deal. Splits don’t really mean anything.
Normally, you would be right — but not in VXX.
VXX History
This is not VXX’s first rodeo with reverse splits..
VXX — and its predecessor (also VXX, but that’s a long story) — have reverse split several times since the original VXX was listed in 2010.
In that time, VXX has destroyed millions and millions of dollars of wealth.
VXX just … goes down.
Yes, it will have short periods where it rallies like it did last March and April…
But here we are a year later and the stock is now reverse splitting, having blown almost 87% of the value from the top last March:
Losing
When the VIX futures are in a contango (futures price is higher than the spot price) as they are over 80% of the time, VXX is generally going to lose — and lose a lot.
The key to the reverse split is that it is going to lose a percentage of its value …
You can see the profit in this chart:
The blue plots are VIX futures on Friday’s close. The Black are Monday’s close…
The profit in VXX is the movement of the dots on the curve … which doesn’t really move.
The only thing that moves is where those dots appear on the curve.
The money VXX lost is produced in the blue dot’s moving to the black dots on a day-to-day basis.
The reverse split is important because of that percent VXX loses.
When VXX is 10, this movement might produce a loss of .5% a day, for instance a nickel on a $10 stock.
However, with the stock now trading $36, that .5% is now 18 cents per day.
Over 20 days we are talking 3.60!
This is on top of the percentage moves it can make if the VIX is actually DROPPING (which it currently is).
But, Mark, don’t market makers price in contango? Yes and no.
They certainly take it into consideration, but remember they are trading the volatility…
They are delta hedging every day, so contango for market makers is not the same consideration it is for a long put holder.
In general, put holders have a huge edge to sit and wait for VXX to die because volatility prices movement BOTH ways — not just down….
And VXX, except in rare occasions, just goes down.
This is going to open up my Volatility Edge service to a whole new swath of downside plays in VXX that simply were not there before.
Because WE can calculate the daily decay in Vol Edge and then look at option prices, we can create short plays that have true edge to them.
Quarters become dollars and dollars become many dollars…
It’s all about the decay in the product produced by contango — PLUS VIX going to 12 or 13, which is where it’s heading.
That’s also a market the rush of new traders who emerged over the past year have no idea how to trade. I’ll show you how to profit off their inexperience on Wednesday. AND I’ll give you my best play for the rest of the year.
Anway, add in the fact that option premiums are getting cheaper and I have a recipe for profitable put buys.
The day they list options on the reverse split VXX I (and my Volatility Edge students) will have a short trade that is almost certainly going to make money.
I, for one, can’t wait. I’ve been dying for this news to hit.
The VIX light is Red …
Your Only Option,
Mark Sebastian