To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks. -Benjamin Graham
From the CBOE website:
The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be the world's premier barometer of investor sentiment and market volatility.
When our market is down, and especially when it is down for at least 2 days in a row as we have just seen, the VIX begins to rise. When volatility increases the VIX has been known to move 10, 20, 30, even 40+% in a day, in fact that's not uncommon. Here are 3 of those radical moves this year:
- Feb 19th-Feb 20th VIX up 19.25%
- Feb 22nd-Feb 25th (over a weekend) VIX up 34.01%
- Apr 12th-Apr 15th (over a weekend) VIX up 43.2%
And besides those there were ten additional times that it was up over 10% in a day in just the last six months. Here's a 3 month of VXX:
To take part in this action one must use an ETF unless you actually wanted to go out and buy all the specific futures that make up the index, and unfortunately none of the ETFs which track the actual index do a perfect job, but my personal favorites, and the three I actually use myself, are for the upside of volatility, XIV and SVXY, and VXX for the downside. The reason I use 2 different ETFs for the inverse VIX is because I have used XIV since its inception and there are still no options available for it, as there are for SVXY.
INVERSE VIX: XIV's real name is Velocity Shares Daily Inverse VIX and its purpose is to replicate, net of expenses, the inverse of the daily performance of the S&P 500 VIX Short-Term Futures Index. That's a mouthful but all it means is that it was created to do the opposite of short-term VIX. If you research all of the ETFs which either follow the VIX or are meant to be inverse, which I have, you will find that not one of them performs with as much volatility as the index itself. That said, XIV does a good job of being consistent in its correlation to the index and is therefore trustworthy as an ETF.
BULL=XIV: Downturns in the market cause VIX to skyrocket, so we would expect the opposite from XIV and in a bull market we would expect XIV to thrive. Let's take a look at the last year.
- One year of XIV: June 12th 2012-June 11th 2013 $9.19 - $20.01
- Up 117% for the 365 days
- If we cherry-pick, starting with the lowest day in 2011, Nov 25th, to June 11th this year: $4.91 - $20.01...307% gain in less than 19 months!
The FED, Profits & Cash: Obviously if the market is in bull territory XIV is the way to go. So the real question here is do you think we are still in a bull market, experiencing a healthy pull-back, or do you think the fun and games are over and it's time to cash out. There is a lot of fear in this market, witnessed lately by a couple of corrections, but the essence of what has been driving the markets up has not gone away. The main driving forces for this bull run have been the Fed and its relentless 0% interest rates, remarkable profits from numerous companies who have taken the austerity measures they needed to survive by trimming their labor and extraneous costs, and tons and tons of cash which has been sitting on the sidelines since 2008.
The fear of the Fed eventually undoing their 'easy-money' policy is not something to be taken lightly, but what we see in the market is an impression of a pretty far off future, and if we can get some of that foreboding out of the way in the form of corrections today, I'm all for it. It's far better to absorb fears in the market over time than to experience a whopping crash from the totally unexpected, and for that reason, I have welcomed each downturn we've seen as another buying opportunity.
Company profits in general have been outstanding and have regularly beat the Street's expectations which certainly has helped the market at each quarter's end. I expect this trend to taper off a bit but ultimately to continue through the end of 2013 and then of course we'll have to see what a new year brings.
Cash has been on the sidelines for a long time, but the Fed's monetary policy keeps that cash increasing. So even if hundreds of millions of dollars are pumped into the market driving it up, at least for now, billions of dollars are right behind it to fill in the gaps and maintain pressure. That's what the Fed was hoping, and so far it's worked. Some of the concerns the Fed has are of an over-stimulated economy where we grow way too fast as well as the impending inflation which is bound to pop its ugly head up in the next decade. In attempt to avoid those scenarios the Fed has linked their policy to the unemployment numbers which makes sense. If the idea is to grow the economy, jobs are the purest indicator of how you're doing. Another indicator is wages for those jobs, which has not been such a pretty picture but wages have a tendency to lag in a recovering economy. This also makes sense as it takes time for companies to be able to take that risky venture into expansion and hiring when the possibility of bankruptcy for so many is a not so distant memory.
Buy & Hold: From within the name of the ETF itself, 'volatility', this is probably not a vehicle for the faint-hearted, but for the bold, I feel that it has tremendous upside potential through 2013 and beyond. I chose to write this article as I was watching XIV on Wednesday the 13th of this month and saw it fall below $20. I immediately thought, "BUY!" Well, by the time you read this, XIV will either be all the way down to $19 or $18 if the market continues to slide, in which case I still say, "BUY". Or if we get back to the norm of the bull market then it will be well on its way to $25. If that's the case I still like XIV below $22 based on the technicals, how the RSI and Slow Stochastic have acted over the past year. On Wednesday it broke through the 200 day moving average on the downside but quickly made its way back above it and I expect it to recover and break through the 50 day moving average which is around $22.90 within a couple weeks, if not days.
XIV is an excellent way to capitalize on this market. My suggestion is to phase the volatility out of your mind. Buy XIV where you think you paid a good price, then hold it. Unless you're a day or swing trader there is no reason to get antsy over big moves in this ETF, because really that's all it does, makes big moves up and down. My forecast is for XIV to be up 50% from its current level by the end of this year, and I can't wait to find out if I actually underestimated here.
Conclusion: Granted, we could have some catastrophic event or a series and combination of negative events that could send our markets down and that would create a strong downturn in SPY, and therefore XIV, but looking at the past 2 years there has been so much bad news that this market has absorbed I am betting on a continued run. For more detailed reasons why, check out my last article, "The Tightrope The Bulls Are Walking: Balance In Spy". When the markets continue upward, XIV is the wave I want to be on.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in XIV over 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: This article is for entertainment purposes only and in no way is a solicitation to buy or sell any equity.