Scalper1 News
I wrote an article last week about shorting VXX but that turned out to be a bad idea. But given what has transpired in the markets since then, shorting volatility has never looked this favorable. An oversold market and historically strong VIX and VVIX rallies means volatility is extremely overbought and due for a move down. Last Friday I wrote an article about one of my favorite trading vehicles, the short term VIX ETF VXX (NYSEARCA: VXX ). I said at the time that with volatility spiking on the short end that history suggested that it was a good time to short VXX. When short volatility spikes VXX outperforms but that condition is always temporary. I also warned against further moves higher in VXX as it is a high risk/high reward strategy that can be gut-wrenching to endure. Well, we all know what has happened in the last couple of days and shorting VXX was a big mistake. But since the situation has materially changed since Friday’s pre-market, I feel a new look at the trade is warranted because there are now more compelling reasons to stick with the short and/or add to the position. My original idea was based solely on the fact that the VIX had spiked on the front end late last week as China began to dominate the headlines. The US market (NYSEARCA: SPY ) hadn’t yet seriously deteriorated and I incorrectly thought we had another run-of-the-mill mid-20s spike in the VIX on our hands, setting up a great short for VXX. Obviously, I was wrong and my short position on VXX has lost roughly 25% of its value in the last two days. So what has changed? The first and most obvious answer to that question is that VIX (and VXX) has continued to spike. The VIX has put on an impressive and in fact, historic rally in the last few trading days. Here’s a five year chart of the VIX; you can really appreciate the magnitude of the rally we’ve seen in the past few days when viewing it in historical context. (click to enlarge) One of the things that has changed since my original trade idea is that the VIX is heavily overbought. The VIX rarely reaches overbought on the 14 day RSI because it tends to spike and fall instead of rally. We’ve seen a rally in the last few days and that has sent VIX’ 14 day RSI to 89. That’s an extremely overbought level and that is one reason I think the short VXX trade is still a good idea. As VIX moderates we’ll see VXX move down. Whenever we’ve seen this kind of overbought condition in the VIX in the past five years we’ve seen it move sharply down over the ensuing days and weeks so there is no reason to think that won’t happen this time. The second condition that has changed since my last article is that the broader market is now oversold as well. Here is a similar five year chart of the SPY to show what I mean. (click to enlarge) We can see that the MACD and RSI are showing extreme oversold conditions that mirror only those of the late 2011 tantrum the market threw. Of course, after that subsided, we moved substantially higher. I don’t know that we’ll move substantially higher in the SPY but we don’t need that to happen for the short VXX trade to work out; we just need it to stop going down. Given the condition the market is in right now we are certainly due for a bounce. Third, the volatility of the VIX index, or VVIX, has also spiked to historical highs. Consider the events that have occurred in the past 10 years with the financial crisis being one of them and then ask yourself if today’s events are more concerning; I think the answer to that is a resounding ‘no’ so that makes the action in the VVIX even more perplexing. Here’s a five year chart of the VVIX to illustrate my point. The VVIX actually exceeded 200 during yesterday’s action, a number that has never been reached before. Even recent panics in the market have caused VVIX to spike to the 120 or 130 area so cresting 200 is quite extraordinary. That tells me there is excessive panic in the market and that condition cannot persist. By definition, panic is temporary. Given all of this and the original trade idea that VXX cannot stay elevated forever, I think the evidence that VXX should fall in the coming days or weeks is quite compelling. We have a VIX and VVIX that are both extremely overbought after historical rallies and a broader market that is begging to rally. I don’t know if we’ll retake the highs on the SPY this year but as I said, we don’t need that to happen for short VXX to work. The panic will subside at some point and VXX will tank again; it always does. The ride to get there is bumpy and stomach-churning but the rewards can be great. Please understand that despite how good the setup looks a short VXX can still go wrong in a hurry – as we’ve seen since I recommended it on Friday – but the odds of a favorable result are exponentially higher now than they were on Friday. I just wish I had waited. Disclosure: I am/we are short VXX. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Scalper1 News
Scalper1 News