The VIX Can't Stay Elevated Forever

Aug.11.11 | About: iPath S&P (VXX)

The VIX has skyrocketed over the last week, streaking higher by as much as 50% in one day. Today, Wednesday the 10th, the Fear Index closed at 42.99. About a month ago I wrote an article which basically stated that it was time to buy the VIX amid the impending global economic problems. I am now ready to switch, and begin to look at strategies to play the index on its inevitable return lower. The index has proven over the years that it cannot stay at hugely elevated levels for very long, maybe only a few days, before it comes crashing down.

The catalysts we may see for a turn-around are many. Equities will simply become too cheap not to own at some point, and buyers will return. Another, just as likely, scenario is the Fed announces plans for QE3 or other stimulus which will prop up equities yet again (Jackson Hole meetings at the end of August). Although most of the fundamental problems will still exist in the US and Europe, the VIX should react by moving lower. The price of insurance is not stable, and the index has proven that it can ignore longer term problems over the last few months and actually move to levels normally seen in healthy financial environments. Before the recent spike the VIX reached as low as 14.5 in early July, which was post-crisis lows even though all of the fundamental problems existed in the market.

A possible strategy to take advantage of the down move while limiting exposure to further upside explosions is to buy VXX puts. Even if the VIX continues to spike higher, owning the puts is still a solid strategy.

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