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I've said it before and I'll say it again: now is the time to position yourself long on volatility. Market volatility can come from anything, including unexpected news events, economic worries and uncertainty, and other global issues -- and we've gone way too long without it.

Why is the VIX an Important Indicator?

The VIX (Chicago Board Options Exchange Market Volatility Index), commonly referred to as the fear index, measures the implied volatility of index options traded. Basically, it represents the market's expectation of volatility in the coming thirty day period.

The VIX is really a rather cool instrument to get a feel for how the market feels. If the VIX is riding under the 20's, generally the market sentiment is good and well. Should the VIX move up over the 30's, market sentiment usually drifts toward unease.

In a bull market, like we're currently in, the VIX generally rides nice and low. In a bear market, or the midst of global unease of some sort, the VIX can take breakneck spikes upward.

In this day and age, there are no shortage of crazy things that happen that can spike the VIX: terrorism, psychotic artificial intelligence trading algorithms gone wrong, devaluation of global currency, random market halts, or (even worse) Kim Jong Un attending a Bulls playoff game with Dennis Rodman.

I'm positioned to make money when the next volatility strikes, and you should be, too.

The VIX Is At All-Time Lows

"Buy low, sell high"

-Every idiot that's tried daytrading from their home E*Trade account

Generally, I hate that rule. I state it a bit differently:

Buy into sell-offs and sell into rallies.

- QTR, slightly less of an idiot, but not

The VIX, right now, is extremely close to its all-time lows, dictating to me that it's a great time to open a long position.

According to Investopedia's definition of the VIX:

The first VIX, introduced by the CBOE in 1993, was a weighted measure of the implied volatility of eight S&P 100 at-the-money put and call options. Ten years later, it expanded to use options based on a broader index, the S&P 500, which allows for a more accurate view of investors' expectations on future market volatility. VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in the markets.

... we are looking at some extremely complacent times for the market.

The VIX Always Spikes Eventually

So, check out the chart below. After the crash in 07', the market hasn't seen a sustained VIX below 20 for more than a year.


(Click to enlarge)

Look at the previous points of major volatility for the global markets -- it's usually right when we least expect it. The more complacent we get about our attitude towards the market, the more likely we are to forget that things can, and often do, go wrong out of nowhere.

Do you think that people the morning of 9/11 knew it was going to happen? Of course not. Do you think people the morning of Black Monday were expecting that to happen the weekend prior? What about the 2007 bubble? The dot-com bubble?

I hate using semi-sensational examples like these, but the point I'm trying to make is that volatility just happens out of nowhere, usually. The longer we go without it, the more likely it is to happen, in my opinion. We've now gone about a year and a half without any serious volatility. One of my patented archaic looking diagrams graciously provided to us by the kind folks at Microsoft (NASDAQ:MSFT) Paint might help out:

Last week, the VIX closed around 13, the lowest it's been in a very long time. The Wall Street Journal provided me with the VIX all-time lows:

The market's fear gauge doesn't have a care in the world these days.

The CBOE's Volatility Index, or VIX, recently fell 7.2% to 11.69, falling below 12 for the first time this year. The last time it hovered around current levels came in 2007.

Considering how far the VIX has fallen, all-time lows have now come into sight. The record sits at 9.31 on Dec. 22, 1993. More recently, it closed as low as 9.89 on Jan. 24, 2007.


(Click to enlarge)

It's bull markets like these where people start to lose touch with reality. "Doesn't have a care in the world", the article states. Isn't this usually when we let our guard down, and bad things happen? Refocus yourself, toughen up and embrace that the market can be an unforgiving teacher. It is not all sunshine and rainbows in investing, volatility can come from nowhere and ruin people.

A Bubble Burst is coming

Also, if you're from the camp that I am, which is that we are producing another Fed inspired bubble that will soon burst, there is absolutely no excuse for you not holding the VIX long through some financial instrument in your portfolio.

I still contend that the end of the Bull Market is near, and in a recent article said:

People are piling into stocks like the days of yore. Big names in investing are publicly calling for the public to keep pouring into stocks. CNBC and Seeking Alpha are among the many sites where contributors continue to advocate taking long positions in the market now - and that's actually one of the big things that worries me.

Just like a lot of things in finance, by the time the public starts to get the message, the smart money has been made. It's an unfortunate fact, but every bull market must come to an end and there's always bagholders that wind up buying at the market's highs. This is usually made up by the uninformed public and the mom & pop investors who get the message years late. The same thing happens with individual equities when they reach peaks; someone gets stuck holding the bag and it's usually the commonfolk. Nobody likes being the last one to leave a party and, unfortunately, I contend that this is the point that the market as a whole has reached.

It is also worth noting that the volatility index ($VIX) is extremely low (hit a low under 12 today) and that low volatility isn't always a great sign. Just as it can be a sign of consistency when it's between 20 and 35 as it has been, the very low number could be signaling a major upheaval in trends coming and the tide turning on a much larger scale. The Central Banks have given the public the impression that stocks are untouchable and the market will never die down. People are pouring (sometimes borrowed) money into stocks. What could go wrong?

When the market starts to pull back, it's going to be a head for the exits en masse. When that happens, look for the VIX to go through the roof.

Conclusion

This one year chart of the VIX shows how quickly we can move from the 40's down to the teens. You need to know that we can move up just as quickly. I am counting on seeing market panic on our next major couple of sell-offs. Panic means volatility. It's really easy to say, "that'll never happen, we'll keep going up," but it's investors not in tune with reality that make those remarks. The not-so-cute facts of the stock market are that:

  • Panic happens
  • Bear markets happen
  • Corrections happen
  • Volatility happens

Will you be ready when it does happen? I will.

As always, best of luck to all traders.

How You Can Trade the VIX:

  • Go long volatility ETFs, like VXX
  • Buy ETPs that track the VIX, like UVXY and CVOL
  • Buy VIX call options
  • Buy call options for VXV
  • Buy S&P VIX Mid-Term Futures VXZ
  • Buy S&P 500 VIX ETF listed as VIXS

Disclosure: I am long VXX. 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.

Source: The Bulletproof Case For Going Long On Volatility