Scalper1 News
VXX has spiked in recent days on China fears. But I think the conditions for a short of VXX have been met. Contango has disappeared and that has been a reliable signal in the past. I’ve written several times in 2015 about volatility and specifically, shorting the popular short term VIX ETF proxy VXX (NYSEARCA: VXX ) as I’ve taken the occasion of various spikes to bet on normalization. Last time I wrote about such a trade it was during the July meltdown stemming from the now-distant Greek crisis and that trade returned very nice profits, as you can see below. Well, here we are again as the VXX is spiking once more on China’s woes or any other global event investors can think of. (click to enlarge) My basic premise for entering a short VXX trade is pretty simple; wait for a spike in VXX, assess the reasonableness for a sustained higher VIX level and if there is none, short VXX. It really isn’t more complicated than that. VXX is a great vehicle to short because of its famous contango. It costs money (most of the time) to hold VXX due to contango so the opposite of that is that shorting it has a natural tailwind. This is the second cue for me in knowing when to short VXX and when to wait for a better entry point. But first, let’s assess why the VIX is spiking. Seems to me market participants are up in arms about China’s most recent meltdown and while that’s fine, just like the Greek crisis, I believe fears are overblown here. S&P earnings are also suffering somewhat and the market is losing leadership in a lot of ways so for me, that is a much bigger problem than China’s latest bubble popping. I know there are many people that would disagree with me but I just don’t get it on China. Therefore, the first condition of my short signal has been met; the reason for the spike seems improper and in particular, the magnitude with which VXX has spiked. We’re up double digits in two days on the VXX and for what? The second signal I mentioned is when VXX is no longer in contango, that has historically been a great time to short it. I like to use VIX Central to chart the VIX curve and determine the level of contango because it makes it easy for even novice VIX watchers to understand what is happening. I’ve pulled two charts from VIX Central below to illustrate my point. This first chart is a straight look at the VIX curve. Since the VXX deals with short term VIX contracts, we’re really only interested in the first two months. As you can see, as of yesterday’s close September and October were at exactly the same level and even November and December were only pennies higher than the front month. That means contango has disappeared and when that has happened in the past, it was a great time to short VXX. This chart shows the level of contango between the first and second month VIX contracts for the past several years and as you can see, flat contango and backwardation are rare. But when either of those conditions are met, we are usually due for a sell-off in front month VIX. That means that when we reach the level of contango we are at right now (zero, the red line on the chart), while we may move a little higher, history suggests the odds are heavily in favor of shorting VXX right now. So here’s the setup; the SPY just hit a six month low yesterday and after the beating the market has taken in the last couple of days, I think today will be a flat to lower day. That means VXX will probably be higher on Friday and that is where I will make my short. I will use the recent spike in VXX to short it as I think we are nearing the top of this particular spike. Now, I’ll make my standard VXX trade disclaimer because I don’t want anyone to get the wrong impression. Trading VXX is very risky and extremely volatile and thus, you must understand that the potential reward is high but so is potential risk. Please understand what you’re doing before taking a long or short position in VXX because it moves around a lot and can make or lose you a lot of money in a very short amount of time. I’ve been on both sides of VXX trades and I can tell you it can wipe out a lot of value quickly. The odds are in favor of a VXX short right now and I think today is the perfect opportunity to take a short position in VXX given that the spike in volatility seems overblown. I also think the market is near a base and will rally from here so that is also a favorable setup for shorting VXX. This position is not without risk but given the setup we have now, VXX shorts are heavily favored here. Good luck out there. Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in VXX over the next 72 hours. (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