Trading the VXX

Jan 23rd 2017

8:00am (EST)

We often talk about stretch in the indexes and last week's pullback to fresh lows was clearly a warning sign. Obviously, Friday's rebound looked good on paper and today's action will be imperative in keeping the bears at bay. The bulls will need to keep volatility low as traders were heavily buying February protection throughout last week.

The VIX options pits were very active last week as traders are loading up for a 3%-5% pullback in the market over the next month, or by mid-February. There are a number of ways to trade the VIX and I often profile trades when the time feels right. Premiums on VIX call and put options can be somewhat expensive but rightly so because of the direct hit or profit they make on unusual and highly volatile trading sessions.

The "crowd" has been focusing on the action in the iPath S&P 500 VIX Futures (VXX, 20.71, down 0.83) despite shares continuing to set fresh 52-week lows. The major moving averages are still in a major downtrend with risk to the high teens on continued weakness. Fresh support is at 20.50-20. Resistance is at 21.50-22.

VXX Chart

Traders were buying the VXX February 25 calls (VXX170217C00025000, $0.40, down $0.25) and the VXX February 30 calls (VXX170217C00030000, $0.17, down $0.11) throughout last week. The losses in both aforementioned call options were pushing 40% on Friday alone as hype of a selloff was just around the corner played like a broken record.

We have been mentioning the current trading range could last into February and why we have stayed away from buying "protection". While the slick talking pros say you need it as buying VXX call options protects your portfolio, it's like buying insurance when playing blackjack. When we play 21, we have to feel the environment and how our stack is going before wasting money on insurance.

I also don't like paying for insurance because timing the VIX can also lead to a triple-digit return with the right options. Given the technical setup and the chance for the low high teens to come into play, perhaps put options are the way to go. Remember, if I feel the market is going to sink, I sometimes buy put options on the indexes.

The VIX is different in a way that we are buying put options on hopes of a higher market. The will cause the VXX to continue its slide along with the VIX that I have said has the chance to test 10 and possibly single-digits.

There are weekly and regular monthly call and put options that trade on the VXX but the monthly provide more liquidity with tighter bid/ask prices. The VXX February 20 puts (VXX170217P00020000, $0.81, up $0.18) jumped nearly 30% on Friday after opening at 69 cents. If VXX trades down to 18 by mid-February, these put options will easily double as they will be at least $2 in-the-money. Over 4,000 contracts traded on Friday.

The VXX March 19 puts (VXX170317P00019000, $1.02, up $0.14) gained over 15% on Friday after opening at 92 cents. If VXX trades below 17 by mid-March, these put options will double as they would also be at least $2 in-the-money. This will also give the trade an additional month to play out and they are roughly two months away from expiration.