Expecting Market Disappointment This Week? Play It With A Volatility Fund

Includes: TVIX, UVXY, VXX
by: Christopher F. Davis

FEAR! PANIC! SELL SELL SELL! This may be what we can expect in the next couple of weeks should Mario Draghi and the European Central Bank not meet expectations for action. The same can be said if we do not hear any policy statements from the Federal Reserve, specifically regarding anticipated QE3. Finally, a triple whammy could occur if we get a disappointing jobs report later this week. Should we be met with disappointment, especially on all three of these areas, expect the markets to sell off and volatility to spike.

The Chicago Board Options Exchange Market Volatility Index (VIX) is a popular measure of the implied volatility of S&P 500 market index. You may hear it often referred to as the fear gauge or the fear index. And it is aptly named, as it spikes when fear is high and plummets when fear is low. The VIX is a measure that is supposed to represent the market's expectation of stock market volatility over the next 30 day period. Right now, the VIX is at $18 and has a 52 week range of $13.66 to $48.00. For those investors who want to trade possible market disappointment this week, you may want to consider adding an ETF that tracks the performance of the VIX, either outright or via in the money call options. However, since the VIX is not directly investable, exposure to equity volatility is often obtained though VIX futures ETFs.

I recommend the following three indexes, in ranking order, that I trade as a play on volatility:

Ipath S&P 500 short term VIX futures ETN (NYSEARCA:VXX): This is perhaps the best way to track the VIX directly in my opinion. This investment seeks to replicate, net of expenses, the S&P 500 VIX Short-Term Futures Total Return Index. The index offers exposure to a daily rolling long position in the first and second month VIX futures contracts and reflects the implied volatility of the S&P 500 index at various points along the volatility forward curve. The index futures roll continuously throughout each month from the first month VIX futures contract into the second month VIX futures contract. The fund has an annual expense ratio of 0.89%, is currently trading at $13.60, and has a 52 week trading range of $12.50-$59.18.

ProShares Ultra VIX Short-Term Fut ETF (NYSEARCA:UVXY): This is my favorite play when I expect short term volatility to spike. The investment seeks to replicate, net of expenses, twice the return of the S&P 500 VIX Short-Term Futures index for a single day. The index measures the movements of a combination of VIX futures and is designed to track changes in the expectation for one month in the future. The fund has an expense ratio of 1.41%, currently trades at $7.35 and has a 52 week range of $6.53-$244.80.

VelocityShares Daily 2x VIX ST ETN (NASDAQ:TVIX): This is my least favorite, but effective play on short term volatility. The return on this fund is linked to twice the daily performance of the S&P 500 VIX Short-Term Futures. It was designed to provide investors with exposure to one or more maturities of futures contracts on the VIX, which reflects implied volatility of the S&P 500 Index at various points along the volatility forward curve. The calculation of the VIX is based on prices of put and call options on the S&P 500 Index. This fund has a 1.65% expense ratio and currently trades at $3.60 and has a 52 week range of $3.12-$109.17.

Right now, volatility is quite low, and given where we have been in the last 52 weeks, the last 5 years, and that there are many fiscal problems throughout the world, a few pieces of bad news could cause this market's volatility will spike. The pieces are falling into place, creating a situation which could disappoint us this week, causing fear to spike, and thus shooting these volatility plays up significantly. Consider picking up some units of these indexes or some in the money call options as a play on anticipated volatility, should you, as I do, expect disappointment.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in UVXY over the next 72 hours.