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Jeffrey Robinson
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Investor and technical analysis author. Articles presented on long term investing signals, sentiment and stock ideas. Master of Science, Business Administration (MSBA), Quantitative Methods. Be sure to check my StockTalks and Instablog for bonus unpublished material.
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  • It's Time To Sell Volatility

    As opposed to investing for the long haul, successful trading requires a great deal of patience, because traders should be focused on finding the highest possible odds in every trade they make. Otherwise, timing the market would be akin to a guessing game in which there is approximately a 50/50 chance of movement in one direction or the other. Traders can be right half the time, but would risk losing all their gains on the times they are wrong. That's why so many market timers fail.

    By definition, a trade with the odds greatly in your favor is not bound to come along every day or every week. It can be frustrating to wait, but in the end, patience pays off, because the odds are so greatly in the trader's favor that they stand to take on very little drawdown compared to the potential reward.

    I believe a high odds set-up has arrived finally in the volatility ETFs, and it's time to short volatility for a multi-day or multi-week trade. Here's why.

    Volatility Continues To Conform To Past Low Volatility Climates

    I speculated in a previous article that the volatility index (VIX) was beginning to exhibit the same characteristics as it did in past decades where it stayed below 20 for extended periods of time and rarely rose above it. This was the probability distribution of the VIX during those years:

    (click to enlarge)

    I have created chart showing the distribution of the VIX since June 22, 2012, the point at which the VIX began to display the same characteristics.

    (click to enlarge)

    The two charts are not identical, but the ranges are very similar. The VIX has rarely closed above 20 and below 12. The middle of the distribution is not quite the same, but I suspect it will begin to conform to the historical distribution over time.

    Options Expiration Week Provides Opportunities

    For whatever reason, the best volatility trade entries (long or short) seem to come during and after options expiration week. It makes sense that volatility could reach an extreme during that week because of all the traders positioning themselves for the expiration of their options. For example, they might roll to a future month or simply close out a losing or winning position to avoid the option expiring. It doesn't really matter why it happens, but the evidence shows that this is clearly the case.

    Take a look at where the VIX closed on options expiration in January, February and March of 2013. All of the last three options expirations were short-term bottoms in volatility. Expiration may not always provide a bottom to volatility, but it usually does happen near a key turning point (top or bottom). It's possible April options expiration could be a top or a bottom. It's too soon to tell, but with the VIX spiking above 17 today, this week could lead to a top in volatility.

    Options expiration is always the third Friday of every month. In April, it falls on April 19th.

    (click to enlarge)

    Volatility Is Statistically Overbought Above 16

    According to my research and assumptions, if we are in a low volatility environment similar to the past, volatility did not spend a lot of time above 16. It could go as high as the low 20's, and I would sort of expect that to happen quite a bit of the time, but as for trading, the risk-reward equations heavily tilts in the favor of volatility shorts above 16. In fact, the VIX spent less than 20% of the time above 16. The VIX is currently trading at 17.40 as of this writing.

    (click to enlarge)

    Entry, Exit and Stop Criteria

    All trades should have clearly defined entries, exits and stops. The entry will be triggered if the VIX were to close above 16 (met on April 17th). The short position should be exited when the VIX closes under 13. This was established using statistics in my previous discussion. The position should be stopped out if the VIX closes above 25 or so. The reason this level is so important is that the VIX never closed above 25 during the historical periods of low volatility, and if it does now, that means the assumptions under which I entered the trade are questionable.

    Conclusion

    The best trade right now in terms of odds is to short volatility. To do this, a trader could use a number of methods. Here are a few:

    1. Purchase or buy calls on a short VIX futures ETF

    • VelocityShares Daily Inverse VIX ST ETN (NASDAQ:XIV)
    • ProShares Short VIX Short-Term Fut ETF (NYSEARCA:SVXY)

    2. Buy puts on a long VIX futures ETF

    • iPath S&P 500 VIX ST Futures ETN (NYSEARCA:VXX)
    • ProShares Ultra VIX Short-Term Fut ETF (NYSEARCA:UVXY)
    • VelocityShares Daily 2x VIX ST ETN (NASDAQ:TVIX)

    I do not recommend shorting a volatility ETF due to the associated risks with shorting any instrument (potential unlimited losses). I prefer to buy puts instead, which have a limited loss potential.

    The entries, exits and stop levels have all been defined based on historical statistics. Understand that a trade like this could experience drawdown, perhaps even somewhat severe drawdown, were the VIX to spike into the low 20's from the 17 level. However, history shows that it should fall back to 11-12 over time. That's why it is critical to be patient in the trade, and anyone purchasing options should use expirations that are at least two months out with fairly conservative strike prices.

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

    Additional disclosure: I am not short VXX, but I do own Jun 2013 @18 puts.

    Apr 17 2:17 PM | Link | 1 Comment
  • The Best Investment In The Last 50 Years

    Real estate salesmen will tell you to buy real estate, stock brokers will tell you to buy stocks, and gold merchants will tell you to buy gold. All of them will claim that what they are selling is the best long term investment, but who is actually right?

    In this article I will attempt to answer the question: Which asset rose the most in the last 50 years? In order to simplify, I will only be looking at nominal prices. I will include CPI, so it will be clear which assets are running at higher rates than the government's definition of "inflation". I did not look at every possible stock or commodity but did cover some of the most popular investments.

    Nominal Price Increases in the Last 50 Years

    (click to enlarge)

    *All commodities are priced in $/cwt

    Here are just a few issues that could be raised with this nominal price data:

    1) The gold standard was removed from the US in 1971, so for nearly 10 years of this data, gold was fixed at approximately $35/oz.

    2) The Dow Jones does not include dividends. Returns are higher if you include dividends and even higher if you assume reinvestment. However, without knowing the exact percentages of people who actually did reinvest, I would not assume that in the calculation. As for adding a small average dividend payment of perhaps 2% per year, the totals are not significantly higher.

    3) Real estate does not include rental income. Again, even assuming 10% returns per year from rental income, the overall ranking would not change. It would be closer to the return from stocks at about 1,380%.

    And the Winner Is...

    The best investment in the last 50 years was clearly gold, and there is really no contest. Buying oil futures would be the next best thing. For all the bad-mouthing of gold as an investment, the numbers don't lie.

    Many will claim gold is in a bubble right now, so you shouldn't invest in it. The main catalyst for gold in the last 50 years was probably the removal of the gold standard in the US, which enabled the Federal Reserve to print dollars without restriction. This caused assets priced in dollars to rise in nominal terms. That was true of all assets priced in dollars, though, not just gold. Stocks are priced in dollars, yet they didn't rise as much. Certainly other commodities priced in dollars didn't beat out gold. The price of gold is definitely tied to rising debt and money printing, but there has to be more to it than that.

    Warren Buffett loves stocks and seems to have a lot of negative things to say about gold, yet anyone holding gold since 1962 has vastly outperformed those who only held stocks. Here's one famous quote from Buffett on gold:

    "Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head."

    Warren Buffett is a talented investor, but his head is in the sand a bit when it comes to gold. Stocks have done very well in the last 50 years. Gold has done better. Buffett is missing something important, but what is it?

    The Principle of Scarcity

    Gold is up 4,600% since 1962. Oil is up 3,100%. The Dow is only up 1,900%, and indeed, since the Dow is composed of oil stocks (or other stocks that theoretically would benefit from rising natural resource prices), some of the Dow's gains can be attributed to increasing commodity prices.

    What is unique about oil and gold?

    1) Oil and gold are scarce and costly to extract
    2) Oil and gold are impossible to reproduce

    Agricultural commodities have not even kept pace with CPI, which is up 660% since 1962. For example, corn is only up 550% and wheat is only up a measly 288%. The global population is up 123%. Wheat has barely kept pace with population growth. The reason is simple: You can create more animals and plants. You cannot create more oil and gold.

    In that sense, if we assume continuous demand, gold and oil are the investments least likely to erode over time due to forces of supply and demand. Anything with a fixed supply and increasing demand due to population growth is naturally a good investment. The demand side of the equation is the part that is very difficult to predict. Energy use could shift from fossil fuels to other fuel sources. Gold could one day lose its luster.

    Conclusion

    For people concerned about inflation protection, the following assets rose at rates greater than the government's CPI figure in the last 50 years:

    • Gold
    • Oil
    • Dow Jones Industrial Average
    • US real estate

    These instruments are good proxies for gold, oil and the Dow Jones:

    • SPDR Gold Shares (NYSEARCA:GLD)
    • PowerShares DB Oil (NYSEARCA:DBO)
    • SPDR Dow Jones Industrial Average (NYSEARCA:DIA)

    Perhaps an equal-weighted investment in all of these ETFs, plus a real estate investment, would enable a retiree to sleep well at night knowing their nest egg is safe from the forces of inflation. However, as stated in the beginning, it's impossible to know if this trend continues, or even if these assets will continue to outstrip inflation. Fundamentally, it makes sense that this trend will continue, since the prices we pay for everything are deeply rooted in gold, oil, stocks and real estate.

    There is a famous saying: "The trend is your friend." Hopefully, this article shed light on exactly what the trend has been in the last 50 years. Invest accordingly.

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

    Mar 25 2:05 PM | Link | Comment!
  • S&P: Never Down Between March 18th & April 4th During Bull Run

    I like to keep this chart handy because it shows seasonality for the bull market that started in 2009. It's helpful because it shows common turning points and seasonal trends. The x-axis is the trading day of the year and the y-axis is the percent gain for the S&P 500.

    One useful observation that is pertinent to the current time of year is that the market has never been down once if you bought on March options expiration and sold a few days into April. After that, things get a lot more choppy into the summer months, although I have reason to believe things won't be so bad this summer for stocks. There is still a lot of negativity about the market.

    (click to enlarge)

    Tags: SPY
    Mar 19 8:51 PM | Link | Comment!
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