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Now Might Be the Perfect Time to Make This Volatility Trade

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Today I would like to pass along a trade I just made.  It has a chance of making 50% if the stock stays flat or moves moderately higher over the next ten days.  I want to share it with you just in case you might like to try it yourself (with some money you could afford to lose – we’re talking about $670 here, per contract).Terry

Now Might Be the Perfect Time to Make This Volatility Trade

The market is going crazy.  VIX, the so-called Fear Index, skyrocketed to 40 yesterday, something it hasn’t done for over 2 years.  It has fallen to about 30 today, and if history is any indicator, it is headed for the 12 – 14 level where it has hung out for the large part of the past two years.

One of our favorite underlying equities (it’s an Exchange Traded Product, or ETP) is SVXY.  It is essentially a way to bet that you think that volatility in the market is likely to fall. When the market is quiet and VIX hangs out in the 12 – 14 range, SVXY inexorably moves higher over time because of a thing called contango (which we can’t explain fully here, but it means that volatility futures are usually higher than the current option volatilities because the future is less certain than the present).

SVXY is the opposite of VXX, an ETP which suffers from the effects of contango. VXX has fallen from a split-adjusted $3000 or so to its present level of $24 over the past 6 years, making it the dog-of-all-dog stocks.  Since SVXY is the opposite of VXX, it has gone up by about the same amount (although it has not been in existence so long).  Its average annual gain has been about 45% since it started up.

SVXY has taken a huge hit with the recent market turmoil, falling from the low $90’s to $58.  When the market settles down, as it most surely will, SVXY can be counted on to move back up to where it was a week ago.  With VIX at 30, history says it is a great time to buy.

Here is what I did today:

Buy To Open 1 SVXY Oct1-15 60 call (SVXY151002C60)
Sell To Open 1 SVXY Sep1-15 60 call (SVXY150904C60) for a debit of $3.35  (buying a calendar)

Buy To Open 1 SVXY Oct1-15 65 call (SVXY151002C65)
Sell To Open 1 SVXY Sep1-15 65 call (SVXY150904C65) for a debit of $3.30  (buying a calendar)

For every two spreads I bought, I shelled out $665 plus $5 in commissions, or $670.

Here is what the risk profile graph says these positions will be worth at the close in 10 days when the short calls expire next Friday:

SVXY Risk Profile Graph August 2015

SVXY Risk Profile Graph August 2015

If the stock is exactly where it is when I made the trades ($58.10), the graph says that I will make a gain of $412, or 61% on my investment.  If the stock moves higher by as much as $10 (anywhere in the range of $58 – $68), I should make about $600, or almost 90% in ten days.  If the stock falls by less than $5, I should still make a gain of some sort.  If it falls by more than $5, I would lose money.  In the event of a flat or lower price, the short calls would expire worthless and I would have 4 more weeks of life in the Oct1-15 calls I own.  Presumably, I would then sell new weekly calls against those positions and lower my net investment considerably (and have more time for the stock to recover).

Implied volatility (IV) of these options is excessive right now (over 100), and if the market does settle down, IV should fall.  That might mean the gains would be not as great as the graph indicates, but there should be significant gains nonetheless.

I really like my chances here.  I will report back on how it works out.

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