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Market Strategy – VIX Support Levels Inflated Due To Middle East Situation

|Includes: iPath S&P 500 VIX Short-Term Futures ETN (VXX)

HedgefundLIVE.com — The VIX is an under-used, misunderstood tool in the financial world. Its based on the 30-day expected volatility of the S+P 500, but does not move in the exact opposite direction of the S+P index like so many believe. The correlation is actually closer to 80% and should be noted as such. IBM and Caterpillar, Inc also share an 80% corr over the last year, and are very different companies. The index itself is mean reverting, always pressuring back down to support. Important levels of support are very visible, and the main reason I am writing this  article. In the chart below, you can see the white horizontal lines act as support, however don’t look at these as resistance it won’t get you anywhere.

With oil prices spiking and unease in the markets, the VIX has begun to move higher. The price of options are based on demand, the demand for insurance. The support level has moved higher over the last two weeks, from 15 to 18. This can be attributed mainly to large money manager’s demand for insurance to protect their clients’ portfolios. This is probably due to the tensions in the Middle East and oil prices. It is not purely from traders.

The ovals on the chart display touches on the support level, the time-frame is 4-hour candles. A simple trade strategy here is to buy calls when the index moves near the 18 level. Based on your risk profile and understanding of option Delta, pick a strike and month that works for you. An overlooked strategy on the VIX is buying puts at peaks. It’s slightly more risky because liquidity in the market moves with the at-the-money strike (which means it will move away from you), but can make for a very nice round-trip trade.  It should also be noted when buying puts, that the VIX tends to crash back down, make sure to have a target level in mind to exit the trade.

On a related note, if someone tells you trading the VXX is a great way to trade the VIX, they are delusional. The VIX  reacts differently. Think of it this way, you wouldn’t trade GS based on your analysis of JPM’s charts, so don’t, especially if you’re technical.

By the way, the VIX closed at 18.61 today (3-2-11), guess what you should buy…!!!!

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