As forecasted, last week found all major averages heading lower as fears of a Brexit crept into the marketplace. Taking a quick look back at my expectations for last week's marketplace, please see the excerpt below from my article "Brexit Weighs On Traders As A Vote Nears":
With that said, I expect the major averages to be more volatile this trading week and end the week modestly lower. The markets don't like uncertainty and that is seemingly all a Brexit vote is bringing with it this week. When I look at my current holdings and asset allocation, I come to appreciate my cash position and hope to deploy some capital in the event that global markets sell off to some degree this week.
With the markets in a more recent uptrend and the S&P 500 briefly breaking through 2,100 once again, last week was a modest setback for the markets. The Dow Jones Industrial Average lost 1.07% for the week, its worst since the one ended May 13. The S&P 500 lost 1.19% for the week and the Nasdaq composite fell 1.92% last week. It's one thing to forecast for weekly action in the marketplace, but positioning and profiting from a forecast can prove a lot more difficult. Having said that, my recent positioning with ProShares Ultra VIX Short-Term Futures ETF (NYSEARCA: UVXY) has proven both prescient and profitable.
I continue to position my portfolio according to my market directional beliefs and as such continue to reduce my exposure to ProShares Ultra VIX Short-Term Futures ETF. Last week, I reduced my short position in shares of UVXY further when shares hit $11.50 a share. I've been holding a core UVXY short position since 2012, but feel the ETF may exhibit a mid-term bounce, spirited by an elevation in the VIX and relaxing of contango. With this in mind, I also initiated a small long position in UVXY (roughly three-tenths the size of my short position) at $11.35 a share. Consider it a hedge if you will and in place to profit should something cause a shock to the markets in the coming weeks. If shares of UVXY continue to moderate lower, I will continue to reduce my short position and have pegged my next target level at $7.75 a share. As a portion of my total portfolio holdings, UVXY short occupies the largest portion of my holdings.
Over the last several weeks I have been lightening my core short UVXY position in favor of cash. I had believed the markets were largely ignoring some of the macro-economic concerns that would prove to be potential headwinds. Additionally, as the S&P 500 failed to make a new all-time high and hold the 2,100 level, I felt it was an optimal time to initiate a small, long position in shares of UVXY…just in case.
The UVXY is an unusual investment/trading vehicle as a long position carries with it a greater risk than a short position. As the very construct of the UVXY is designed to erode in price over time, a long position is understood to be of greater risk and as such requires great market timing. It is with this understanding that maintaining a core short position allows one to benefit from constant share price erosion and adventure with seeking a long hedge from time to time. In short, if you attempt a long position in UVXY, you had better have all your due diligence ducks in a row as it requires a good deal of market and volatility timing.
So with all the aforementioned in mind, nearly a month ago I began reducing my core UVXY short position at $13.50. My plan was to continue to reduce my core position in $2 increments so at $11.50 I took some more UVXY off the table. Having held a core short position in UVXY since 2012, this was my first time reducing the overall position. Once UVXY broke below $11.50 I initiated a long UVXY position two weeks ago at $11.35 a share. Shares of UVXY continued to fall further, benefiting my short position, which is significantly larger than my long hedge. But then the volatility came and brought with it greater fear in the markets. The chart of the VIX Volatility Index below shows a breakout in the fear index.
What has kept the fear gauge under pressure since mid-March had fallen prey to Brexit fears and coincided with options expiration last week. As the VIX spiked, which measures the implied volatility of SPX options and is directly correlated to the UVXY price movement, so with it brought a spike in shares of UVXY. Last week, shares of UVXY that had fallen below $9.50 a share, surged to roughly $17 a share. While it would have been great to capture the full extent of that move with my long UVXY position, I decided not to press my luck. There were a couple of trading days last week where the markets went back and forth intraday with the Dow being down almost 200 points only to rally back and lose only 50 or so points on the day. With all the back and forth movement I decided that with the UVXY appreciating to $14.14 a share, I would take my profits and run. With a roughly 25% profit in hand after just a few trading days, my long UVXY paid off handsomely. I tend to disclose my trading actions through my Twitter (NYSE:TWTR) feed as shown below:
$UVXY sold long position at $14.14 from initial entry at $11.35. Could still move higher and significantly if more volatility arrives
So now what? I've traded UVXY from the long side four times this year, yielding three strong returns and while maintaining my core UVXY short position. Next week is the all-important Brexit vote on the 23rd and investors will likely be jittery leading up to the vote. A risk-off sentiment may boost UVXY higher heading into the vote and with the FOMC seemingly out of the picture for the time being. But then again, this market sentiment may not come to pass as one would have thought the markets would have sold off to a greater degree last week. It's quite the quandary if you are considering a long UVXY position at present, which is why I consider my profit taking last week to be optimal.
Moreover, I believe the best opportunity is at hand to benefit longer-term and with less risk should UVXY surge again in the coming trading days. Why take any more risk than has to be taken with a long UVXY position? Instead and to the contrary, if shares begin to rally again next week, I will be layering back into shares of UVXY from the short side. I'm not willing to take on the risk of timing the UVXY from the long side after already executing that trade. For UVXY traders, big spikes are known to be where you layer on short positions in order to witness and profit from the share price erosion once volatility quells and contango sets in.
The actions and positioning I have outlined for next week with the UVXY is also with consideration to a post Brexit environment and that is where both sides of the trading strategy are covered. For example, if Brexit does occur, the markets will likely erupt from the unknown impact of such an event. Global equities will likely fall as volatility rises. If that takes place, which is a big IF, the long UVXY position benefits until cooler heads prevail and the market accepts and understands a post Brexit, European Union. UVXY long participants will benefit from having carried that risk. But at the same time, UVXY short participants will also benefit from continuing to be able to layer on short positions. When the share price of UVXY eventually erodes, which is inevitable, shorts will profit handsomely. In this scenario, both shorts and longs will profit. Having said that, if Brexit doesn't take place and the UK remains with the European Union, it is likely that global equities will rally, bringing about a decline in volatility and erosion in the UVXY share price. In this scenario, only those participating from the short side will profit. In "short", only one scenario works well from going long the UVXY at this time in the market, but shorting the UVXY works for either scenario outlined long-term.
Disclosure: I am/we are short UVXY.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.