The S&P 500 is now at a higher level than at any time between now and the beginning of the stock market crash of 2008, and the market has closed higher every day for more than a week. All this despite the fact that the United States has a pervasive unemployment problem, a growing budget gap, inflation is rising, and there is looming political uncertainty in the world. Contrarian investors should be looking for ways to profit from the fact that no one seems to be worried about anything right now.
The best strategy is to sell some of whatever you have now while prices are high, take profits, and hold cash to take advantage of lower prices later. (For any contrarian or value investor, I think holding less than 20% cash right now is irresponsible.) Once you've done that, you may want to consider getting a little more adventurous.
This attitude in the market of "buy, buy, buy" at higher and higher prices is reflected in the Chicago Board of Exchanges S&P 500 Volatility Index (VIX). The VIX closed yesterday at 15.84 (see here), which is as low as it's been all year. The last time it got this low in fact was just before the April fall in stock prices, around the time of the BP oil spill. Within two months of that low, the index shot up and fell down dramatically, reaching highs of 45 and a low of about 18.
Two exchange-traded products that track the VIX were around at the time, VXX and VXZ. VXX is made up of short-term futures on the VIX, and in late April of 2010, shares of VXX were trading in the low-70s; within one month, shares went for over 135. That's a gain of almost 85% during a period of time in which the S&P 500 fell about 10%. Likewise, share prices for VXZ (which is made up of three and four month futures) rose over 40% over the same period of time.
Since last April, another VIX-related product has become available, CVOL. Each of the three, VXZ, VXX and CVOL, lost money over time in flat markets (when volatility remains unchanged) because of contango and roll yield. That being said, I think the low levels of volatility justify the risk of losing even as much as 10-20% of the share price in order to be positioned for a correction.
I'm planning to buy VXX this week. I prefer the short-term ETN to the mid-term one because I think it captures the volatility I'm looking for, and I'm not willing to "pay more" in loss to roll yield because of the longer term. (If I didn't think the VIX were headed up, I would be better off holding onto the money and waiting for a better price, right?)
Based on articles by Morningstar and Seeking Alpha author Bill Luby, I think CVOL may do a better job of maintaining value than VXX, but I would like to see CVOL go up and down through at least one correction before I put money into it. I'm not aware of any extra risk arising out of the fact that it's a new product, but if I don't know what the risk is, I would rather not volunteer to be a guinea pig. I've earmarked a certain amount of money I'm willing to put into this position, and I will spend one-third of it this week.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in VXX over the next 72 hours.
