Options Trading: How to Use VIX/VXX for a Market Sell-Off

Posted On July 23, 2018 4:30 pm

I’ve discussed how/why I only use VIX/VXX in a very selective manner; namely the nature of volatility to revert to the mean and the structure of these VIX related products creates a headwind that drives their price lower over time.  This makes them poor tools for long-term positioning or portfolio protection.

But they can be used very effectively for short-term and highly leveraged means of timing a market sell-off.  Now may be the time.

Here are a few things are lining up, with some old-fashioned gut feeling to suggest buying volatility offers a good risk/reward:

Overall volatility as measured by the VIX is back to pre-teen 12.5 level.  It can stay low but this level tends to be a floor. The implied volatility of VIX/VXX options is near 52-week lows.  This is the vol. of vol. and suggests complacency.

3. The positioning in VIX and related products has returned to the largest short position since the last January, right before the ‘Vixapocolypse’. Will people never learn not to pick up pennies in front of a steamroller?

4. The term structure of VXX futures is in fairly steep cantango, meaning front month trades discount to later dates.  This means any blip up in volatility will cause an outsized move in the front month and quick move towards backwardation.  See #1-3 to understand this set up provides tremendous leverage if a vol spike occurs

5. We have several potential catalysts to trigger a nasty, possibly brief, sell-off.  The meat of earnings seasons with both large cap tech and cyclical names which already said I will open factories overseas to avoid tariffs reporting in next few days.

Whirpool(WHR),which also reports tonight, should be particularly interesting; washing machines were the first items to be slapped with import tariffs in January and shares of WHR initially rallied some 10% on the belief it have the competitive advantage over Asian LG and Samsung.
But the follow up steel and aluminum tariffs have made input costs
for WHR much higher and shares have slipped over 15% since that January high.  Maybe trade wars aren’t so easy.

6. The SPY is once again struggling to clear the important $280 level. There lacks a certain of “umph” to the buying. Very scientific, I know😉

7. And, of course geo-political risks.  For the most part these get shrugged off, whether its North Korea, tariffs or just Trump tweets in general. But one day the algos may decide pick one as the straw that breaks the back and the bull. At least for a day or two.

Given the above backdrop I thin buying low cost, highly leverageVXX, currently $31.30, calls at these current levels.


Buy to Open 5 contracts VXX August (8/03) 32 Calls at $1.30 (+/-0.03)

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Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.

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