In case you missed it, the stock market you’ve grown accustomed to–you know the one with light trading volume and low volatility–has gone on summer vacation.
The S&P 500 Volatility Index (VIX) soared 27% on July 31 alone, ending the month with a rollercoaster bang.
Up until now, the dominant chatter by talking heads in the financial press has been how volatility has been virtually non-existent because the VIX is down 29% during the past two years.
Utter nonsense like “the VIX is too low for a market crash” has spread faster than news about LeBron heading back to Cleveland.
Actually, the 46.5% gain for the VIX in July 2014, was the seventh largest monthly rise in the VIX since 1990.
Just ahead of this latest volatility outburst was the 48% spike in VIX in February 2007. That was the same month that hedge funds managed by the now defunct Bear Stearns experienced their first monthly losses ever. Remember how it seemed that wonderfully delusional period of good times would never end?
One July 9 when VIX traded just under 12, we said via our Weekly ETF Picks: “While most market participants are expecting a lack of stock market volatility to be a sustainable trend–we’re betting the opposite. When another short-term pop in the VIX arrives fast and furious, we’ll be ready. We’re buying the VIX August 2014 11 call options (VIX140820C00011000) at $200 per contract.”
How did it turn out? Our August 2014 VIX call options are now up more than 90% and we were able to bag a double digit gain from a major stock market trend that most people missed. Doing the exact opposite of the crowd never felt so good!
Yet, owning volatility–still one of the most depressed asset classes on the planet–-for a strategic trade isn’t the only way capitalize.
ETFs that offer stock market exposure but with volatility protection like the Direxion S&P 500 DRRC Index Volatility Response Shares (VSPY) and the PowerShares S&P 500 Low Volatility (SPLV) are other ways to keep clients invested but partially hedged.
The VIX has already jumped at least 15% or more on eight separate occasions this year. However, a period of sustained volatility has yet to arrive. Still, the prudent course of action is to prepare ahead.
Another way to hedge against higher market volatility is with short ETFs that are designed to increase in value when stocks decline. The ProShares Short S&P 500 ETF (SH) and Direxion Daily Total Market Bear 1x Shares (TOTS) both offer unleveraged daily opposite performance to U.S. stocks. Both funds are short-term trades designed for the non-core portion of a person’s portfolio.
Increasing cash positions within a portfolio is another effective way to manage rising volatility.
Remember: Volatility is a non-core asset class, which means it’s not a buy-and-hold type of asset like real estate or stocks. Also, clients should first have complete exposure to the major asset classes in their core portfolios before diving into volatility geared trades.
Ultimately, the best way to profit from higher volatility is to be long the VIX before volatility strikes. Put another way, prepare for the storm while the sun is still shining.