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Summary

  • Timing a falling VIX is a safer strategy than timing a rising one.
  • A proven metric would be to short UVXY once VIX futures move from backwardation to contango.
  • This article was written solely based off of feedback requests by Seeking Alpha users.

I highly appreciate and take the time to read your comments and suggestions. My ultimate goal in writing for Seeking Alpha is to help you make solid investment decisions. In return, you help me through your feedback. At the end of the day, your money is as important to me as mine. This article was written solely based off of feedback requests by Seeking Alpha users.

In my first two articles of this series, we went over strategies on how to profit from a rising or falling VIX.

"Rising VIX: How UVXY And SVXY Would Have Reacted In 2008 And 2011", here.

"Falling VIX: Profiting From Short-Term Spikes In Volatility Using ETFs", here.

My preferred ETPs are ProShares Ultra VIX Short-Term Futures ETF (NYSEARCA:UVXY) and ProShares Short VIX Short-Term Futures ETF (NYSEARCA:SVXY). These are what I feel most comfortable with. Think of it as my salt and pepper. I have always used them, they are reliable, and I know how they are going to taste (react) when applied to different foods (events). You may have other favorites, and that's ok. You can find a list of the highest-volume VIX ETPs here.

The number one question received on my articles asks about timing. It is also the number one complaint.

Timing - How do I know when to time a rise or fall? I commented to one user that trying to time a rising VIX is like a salmon swimming upstream. You may be successful, but most will either die trying or have their body ripped apart by a bear (when using UVXY). Really in our case, a contango bull.

My recommendation has always been to focus on the backside of a spike in volatility.

I set out to find or research a proven metric to use for timing downside volatility. I could not find any that I agreed with, so here is the result of my research. This metric still requires analysis of future conditions in your execution strategy.

(click to enlarge)

Since May 2009, there have been 15 cases, per the above chart, where backwardation reversed back into contango. This is an average of 3 times per year. As you can see from the chart, timing would be difficult to predict based on technicals. Recently, spikes have been short and more frequent.

My recommendation on timing is to short UVXY when VIX futures move from backwardation to contango. Let's look at an example below.

(click to enlarge)

Starting on January 23, 2014, the VIX futures move from contango to backwardation and then back to contango. At this time, assuming improving economic conditions, you would execute the short trade on UVXY.

(click to enlarge)

Short selling UVXY on February 6th would have been around $83 per share. On February 18th, UVXY was trading at $60 per share. At this time, I would take profits and wait for the cycle to repeat itself. Have an end profit goal set going in. Set a good-until-cancelled order to end the trade at a predetermined price point. Say, you were happy with ending the trade at $65 per share. This would have resulted in a profit of 21.69%. Not bad for 12 days' worth of work.

In the above scenario, I would have sold at the money calls with a time value of one year or more. While the VIX is spiking, I slowly add to a position once I think a top has formed. By the time VIX futures cross back into contango, I am fully invested. If I foresee improving or level market condition over the next 2-3 months, I will hold the option while I enjoy its price decay.

It is hard for me, as a writer, to sit here and tell you when to time the VIX futures. For newer investors, I would practice with this strategy, especially if using options, before executing an actual trade. Nothing in the stock market is guaranteed. However, I believe that UVXY is almost guaranteed to fall over time. Picking the right entry point using the timing highlighted above can lead to sizable investment gains. It is essential for investors using this strategy to gauge economic conditions. Worsening economic conditions with this strategy can lead to high investment losses, such as in 2008.

Some comments have proposed that my advice of relying on your own economic insight for trading the VIX is not helpful and provides little insight. I respectfully disagree. Think of the economy as a microwave. You ask me, Mr. Buehler, how do I know how long this popcorn will take to pop? My response is going to be, it usually takes three minutes. However, your microwave may have a higher or lower wattage than mine. The only way to time it perfectly is to monitor it. If I tell you three minutes and it only needed two, then I am not a good advisor.

I have repeated over and over that timing is essential. You can follow me on Twitter for more current updates. The advice I give in an article written today, if you want a specific answer, may not be the best advice in one month from now when the VIX spikes.

Source: Suggested Timing For Shorting UVXY