Trading the Volatility Index (VIX) Can Be Tricky. Here’s How I’m Playing It

Trading the Volatility Index (VIX) Can Be Tricky. Here’s How I’m Playing It

Posted On April 28, 2021 4:08 pm

The CBOE Volatility Index (VIX) is often referred to as the “fear gauge” as it tends to rise as uncertainty and concern enter the market.

It definitely earned that moniker last March when the COVID-19 pandemic forced businesses to shut down and people to fear for their lives. 

However, as its concerns have receded, so has the VIX — drifting back to its lowest levels since last February. 

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vix 2020-2021 stock chart

One might argue that both people and the market have become too docile.  Tonight, President Biden is set to propose a controversial $1.5 trillion stimulus package, to mostly being paid for by higher taxes from the wealth accumulated in the stock market by both corporations and individual shareholders, which could create stress among market participants, if not a route of selling. 

During stressful times such as the present, the structure goes into backwardation where near-term VIX futures are at a higher level than longer-dated ones.  This is a function of the fact that the VIX’s mean reverting with the expectation that over time things will normalize.

As you can see below — back in March VIX — futures traded at 45, well above the VIX’s 34 reading.  However, the July futures are at just 29, or an even steeper discount than the VIX “cash.”  This speaks to the “reversion to the mean” nature of volatility. 

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vix futures historical prices

While the VIX’s a widely watched gauge, one cannot trade the actual Index.  But, there are various VIX-based products that can be traded for both speculation and hedging purposes.  The challenge is that these products are complicated and tricky instruments with a variety of nuances that many individuals may not be aware of. 

A popular VIX-based product is “iPath S&P VIX (VXX),” which is an Exchange-Traded Note (ETN).

The VXX comes with its own quirks, namely that, over time, its price heads towards zero.  You can see that even with the recent volatility spike, the VXX remains well below where it was a year ago.  

vix ipath series 3 chart

In fact, the VXX has undergone 6 reverse splits over the past decade, meaning back in 2011, it was trading at $31,000 on a split-adjusted basis. That’s a 99.9% loss— not exactly a good long-term holding. 

However, in the short-term, if one can time it right, it’s a powerful tool for both hedging and speculation.  I think that we will get a short-term spike in volatility over the next few days. 

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About author

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.