The holidays offer a perfect opportunity to trade the CBOE Volatility Index [VIX]. Volatility is fairly predictable this time of year, and with the volatility Index, we can be positioned to take advantage of its movement through the holidays and afterwards using a options strategy. For those of you unfamiliar with the "VIX", the volatility index ("VIX") is an index which measures expectations of volatility, or fluctuations in price, of the S&P 500 index. Higher values for the volatility index indicate that investors expect the value of the S&P 500 to fluctuate wildly - up, down, or both - in the next 30 days. It is also know as the "fear index" because a high VIX represents uncertainty about future prices. This Index moves with volatility. It is fairly predictable this time of year, and that is the reason a savvy trader can position him/her (self) for a profitable option play. Volatility during the year fluctuates and can create uncertainty. High volatility means greater movement in the stocks. Lower means less movement. As Christmas draws closer, volatility tends to be almost predictably lower. This is the time volatility takes a vacation. Statistically, volatility has fallen 5 out of the last 8 years during the week of Christmas. There is a phrase known as Calendar Reversion, whereby with fewer trading days, there are fewer opportunities for stocks to take off. There are fewer traders also as people are focusing more on the holiday season than they are trading. Not only do we have the "Calendar Reversion" in December contracting volatility, but come January, we have what is know as the January Effect. This anomaly is known to see price increases in financial securities in the first month of the year. Lower stock prices before January create an opportunity for investors to buy and then sell after the New Year.
Increased prices usually come with the New Year, thus increasing volatility. These two consistent elements of the market create a nice opportunity for an options trader to possibly make a nice profit. The Volatility Index is developed by the Chicago Board Options Exchange [CBOE]. It is trading in a very predictable falling wedge pattern.
The Falling Wedge If you are unfamiliar with this type of stock chart pattern, it is a bullish pattern that begins wide at the top and continues to contract as prices move lower. The wedge forms an extended down trend which we have had now for the last 10 weeks. This pattern is a good sign of decreasing momentum and the likelihood of future trend change. As we look at this pattern, it is important to put the VIX on a watch list and look for the breakout above the trend line before a trade is made. A bullish bias should not be traded until we see that breakout. This is the safest type of trade. Put VIX on your watch list. It should continue lower through the holidays. If (and when) it moves up, it could start in January. We have two types of plays we could make here. The first is to play the upper trend line. Come January, if the VIX is trading on its lower supporting trend line, look at buying a February/March 30 Call Option. This type of play is anticipating the increased volatility, creating more value in the February/March call option for resale. The second strategy would be longer term. In this, look for a break above the trend line and continued increase in volatility. As the VIX breaks the upper trend line, look at buying a call option more at the 45 level toward May/June with the same strategy of reselling at a certain profit point as volatility increases.