By Chad Karnes
The cyclical two-month pop in stock market volatility (VIX) came early this month. Volatility's latest spike took VIX levels up over 30% from its July lows in a hurry.
Volatility has made a habit of spiking higher about every two months, for whatever reason. The cause for the volatility spike and subsequent market decline has typically been varied, whether war, economic data, or Reserve Bank musings, but it seems to always result in a similar outcome; a quick spike higher in the VIX that savvy investors can take advantage of.
Check out the chart below which we have been tracking since early 2013 and displays those volatility spikes over the last year that have occurred around every two months or so (the blue cycle lines). This trend has been occurring since November 2012, offering numerous profit opportunities along the way.
The chart above is one provided our subscribers that utilizes the VXV Index (the 3 month out volatility index) rather than the more widely followed VIX Index (the 1 month out volatility index), but both indices have shown a tendency to rally together every two months and besides their time difference are very similar to each other.
When looking at the chart, what also should be noticed is that this volatility index has spent very little time below the 14 level, a trend going back to the early 1990s. And, when volatility nears these extreme lows just as it did in June and July, contrary to what you will hear from most other media outlets and talking heads, is exactly when you should to be protecting your portfolio from such unexpected market downturns and concurrent volatility spikes.
At times when investors expect a low risk of loss, is inevitably when such losses typically occur.
Our subscribers saw how well utilizing such a contrarian strategy works when we suggested buying the August $11 VIX Call options in our 7/9 Weekly Pick for $200, just before the latest spike higher where we took a quick 20% gain. The time to be most defensive and buying insurance is when prevailing complacency and expectations for a market correction are very low, and those times are often identified by low volatility readings.
We also suggested a similar strategy throughout our July Technical Forecasts where I reminded our readers, the best time to buy home insurance is before the house catches on fire, not after. The VIX is a similar insurance on your portfolio and rallied over 50% the rest of that week as the October Call Option recommended just before the market's tumble, on 7/30, remains profitable.
Being long volatility when it resides near all time lows is a contrarian play that keeps downside risk very low, but upside potential very high, and those are the kinds of high probability trades we like. When the VIX sits near all time price lows, the risk of loss is also at its all time low, making it more attractive as an investment as the likelihood of losing money lessens.
Right now, volatility is correcting from its latest spike and some profits have been taken, but if the VIX continues to fall, we again will likely have another great opportunity at high probability portfolio protection and profits.
Disclosure: No positions
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