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We think now is a great time to short the iPath short-term Volatility Futures ETN (NYSEARCA:VXX). The index tracks the two front months of the VIX on a rolling basis.

Traders use the VIX as a proxy for fear in the market. Traders purchase VXX notes in a bet that volatility will rise. Recent market action in the S&P 500 (NYSEARCA:SPY) and Dow Jones Industrials (NYSEARCA:DIA) suggest the VIX and VIX futures, and therefore the VXX ETN, are about to get pummelled. We recommend shorting VXX or buying puts on this ETN at this time.

Thesis for this short

Until last week, there have been only two times when the VIX (^VIX) closed two consecutive days of at least 26.6% up, followed with at least a 6.39% move the next day. These “back-to-back” rises are truly rare for the VIX. We all know that history is not perfect, but it's still intriguing to dig into the historical data and study the last two times when the VIX spiked “back-to-back” for any relevant perspectives.

Time Machine to August 1990 Invasion of Kuwait

The first time back-to-back upward moves occurred during August of 1990. Take a look at the numbers first.

VIX closing price

Day

Date

% Change (from previous day's close)

20.43

08/02/90

Thursday

-5.59%

28.74

08/03/90

Friday

40.68%

35.91

08/06/90

Monday

24.95%

And here is what happened to VIX and S&P 500 (SPY) contemporaneously. It's not quite what one would expect from such a powerful move in VIX.

Day

VIX

VIX % Chg from the day of spike

S&P500

S&P500 % Chg from the day of spike

08/03/90

28.74

N/A

344.86

N/A

08/10/90

25.75

-10.40%

335.52

-2.71%

08/17/90

27.53

-4.21%

327.83

-4.94%

Thus, the next leg may be down, with volatility a good short.

Time Machine to EU Debt Crisis of 2010

The latest two-day advance occurred in May of 2010. Here are the numbers:

VIX closing price

Day

Date

% Change (from previous day's close)

24.91

05/05/10

Wednesday

4.49%

32.8

05/06/10

Thursday

31.67%

40.95

05/07/10

Friday

24.85%

And here's what happened to the VIX and S&P500 (SPY) contemporaneously. This time the VIX's spikes “seem” more promising. However, we can dig a little deeper.

Day

VIX

VIX % Chg from the day of spike

S&P500

S&P500 % Chg from the day of spike

05/06/10

32.8

N/A

1165.87

N/A

05/13/10

26.68

-18.65%

1157.44

-0.72%

05/20/10

45.79

-39.60%

1071.59

-8.08%

Sharp fundamental analysts will observe that this last time coincides with the above mentioned “European Debt Crisis 1.0” crash of 2010. So at first glance, it seems to hold some value of “foretelling” imminent trouble in the market.

The “European Debt Crisis 1.0” crash started on April 23 with the S&P 500 closing at 1,217.28, and ended with a close of 1,022.58 on July 2. During this down-trend, the S&P 500 fell 15.99%. By the time VIX spiked on May 5th, the S&P 500 was already well on its way already down 7.3%. In other words, the VIX has already missed about half of the move. This move by itself doesn't suggest another downturn unless other macro risk factors emerge on investors' radars.

Source: An Opportunity to Short the VIX