A Short Case For Short-Term Volatility, Which You Can Then Short

Includes: CVOL, UVXY, VXX, VXZ
by: Quoth the Raven

In the long-term, I'm not predicting volatility on the whole for 2014. I think we're going to come out of this year the same way we came into it - with the VIX low, and the market healthy. As the Fed continues to taper, weaning the economy off its junkie like fix of infusing it with cash, the market returns to a more sober state of health. For the year, I'm predicting 3-5% growth in the major indices. To get there? It might be a little bit of a bumpy road - as we've seen so far this year - but that's not necessarily a bad thing.

In the short-term, there does seem to be a bit of a case for going long volatility. Why? We have a couple of things going on at once.

First, the debt ceiling is approaching yet again - and there's no doubt in my minds that the boobs in our government on both sides of the aisle are going to find a way to turn it into a travesty of some sort - before eventually sorting it out the days before we default. We get this same story every time we have a debt ceiling issue: the deadline approaches, the government makes fools out of themselves, the markets get skittish. Then, at the last minute, some pork laden bill gets pushed through to handle it and the markets rally. We just saw this happen in October of last year, remember? USA Today reported:

In less that three weeks, the U.S. Treasury will have just $50 billion in cash on hand, Treasury Secretary Jacob Lew told Congress Friday.

That sounds like a lot of money, but the government can spend as much as $60 billion a day - especially in February, when tax refunds alone can total $15 billion.

That means the government will run out of borrowed money by Feb. 27 unless Congress increases the debt limit, Lew said. The government hit that limit Friday, causing the Treasury Department to begin taking measures to conserve cash.

"If Treasury has insufficient cash on hand, it would be impossible for our nation to meet all of its obligations for the first time in history," Lew said.

Secondly, we have this little thing going on with the Fed, if you haven't noticed. It's looking like the Fed is going to continue its plans of tapering - which I think is a good idea. However, its likely to give certain investors some pause.

Seeking Alpha, by way of the Wall Street Journal, reported on Sunday:

  • The Federal Reserve is likely to continue scaling back its QE program despite the disappointing nonfarm payrolls report on Friday, writes WSJ Fed watcher Jon Hilsenrath.
  • The FOMC has cut the Fed's bond-buying program by $10B in each of its last two meetings and is set to trim purchases by another $10B at its next get together in March, when it would have another jobs report to consider. The Fed is currently acquiring $65B in bonds a month,
  • Richard Fisher of the Dallas Fed, who votes on policy this year, told CNN after the employment data came out that policy makers are "not swayed by a single number."

Again, I do think continuing the taper is a good idea. I wrote about it in my article, "Welcome Janet Yellen, Now Don't Screw it Up":

So, make no mistake about it, the pressure is going to be on Yellen and how she acts. Personally, I think she'd do well to continue the taper in the midst of this pullback - if it's a Fed induced correction, there's no need to dance around it. We risk far greater peril if we let the Fed continue to inject money into the economy to a point where the public starts to lose confidence in the Fed's ability to help. Then, we'd have ourselves a real mess.

I'd love to see Yellen continue the taper to invite further buying opportunities. This way, the next time the market continues another leg up over 16,000, the move will be au naturale and healthy, just like our recovering domestic economy.

The taper and the debt ceiling deal are likely to add some volatility to the markets in the coming weeks. If you're not going to go long on volatility, it still might be a good short term plan to hold a VIX tracker, like VXX, as a bit of a hedge.

Then, when the debt deal seems to be coming down to the wire, it'll be a great time to short the VIX one way or another (I like shorting VXX). As history can tell us, the US is not going to default and the markets will likely rally on the news of a deal getting done. With that, the VIX should start to pull back towards levels it was at when last year ended.

As I reminded in my last article on the debt deal, making money on VXX or other volatility instruments is all about making sure that the short-term timing is right. Sure, you can get burned on small spikes of the VIX, when shorts are squeezed out of VXX - but, remember that ETNs like VXX are long-term losers - they are not buy and hold securities.

Best of luck to all investors.

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 have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.