Short Volatility Strategies And A Word Of Caution

This week will be a shortened trading week as we celebrate Thanksgiving Day on Thursday for which the markets will be closed. Of course the retailers will be opening their doors in the evening for shoppers to get a jump-start on the holiday gift-giving season. So what better way and time to publish my latest article while wishing everyone a safe and joyous holiday season? In this article I will outline some of my latest considerations regarding the Volatility complex and the proliferating sentiment that finds ever more short participation in the asset class. It is an asset class now is it not?

Through much of 2017, shorting volatility in its many forms and with its many derivatives has been increasingly en vogue. (High society verbiage there me thinks Justin LOL). For fiscal 2017, the VIX itself will possibly maintain a mean average below 15, something previously unheard of and certainly not within the realm of any one’s forecast. This year will prove to be quite the anomaly for the equity markets and volatility. And it’s with this characterization that I find a level of concern that I had not found in previous years. 

Day in and day out I see, hear about and am personally confronted with new traders and investors desiring to dip their toe into the volatility pool. That’s what a sub-15, mean VIX reading will do after all; it can lure the unsuspecting, lesser informed and those lacking experience into an environment of decisive calamity that they have yet to fully understand and appreciate. It has been one of the simplest and true-to-form trades in 2017: Short the VIX or VIX derivatives for each and every time they spike in level or value and in “short order” you will find a significant return on capital deployed.  In the 6 years that I’ve been shorting VIX-Exchange Traded Products it hasn’t been as simple as 2017 has offered it to be. It certainly hasn’t been that immediately rewarding or comforting to participate within the VIX complex. To the extent that I do appreciate newcomers I think it also necessary to warn of the pitfalls that are intrinsic to volatility trading. 

It is because of the rather immediate reward for shorting volatility in 2017 that a sense of complacency may be pervading those participating in the short-VOL trade. NO, that’s being a bit disingenuous! There is definitely complacency among short-VOL traders as I come across it daily. And no, I don’t dismiss myself out of like complacency in participation. It’s natural given the trend. But…but it’s easy to say that and it’s easy to find concern for complacency regardless of where it may be found right? When we speak of complacency it tends to carry a negative connotation. Nonetheless, and as I wax poetically, I’m concerned by what I encounter as I foresee a time where such complacency may be met with…well greater volatility for which greater expertise and even timing may be necessary to extrapolate profits from the volatility trade. Timing will be of even greater need for those who participate with instruments like VelocityShares Daily Inverse VIX Short-Term ETN (XIV) or ProShares Short VIX Short-Term Futures ETF (SVXY). These instruments are not double-leveraged and fail to achieve the same benefits that other 2X VIX-ETPs benefit from like a greater degree of options decay, contango and beta friction.  SVXY and XIV can be marred during and after a VIX spike by beta slippage. If you don’t time your long participation with these instruments properly in an otherwise elevating or elevated VIX environment, it can take a longer time than realized for these instruments to rebound to prior levels. The chart below, from Russell Rhoads of the CBOE, is of XIV and clearly represents this beta slippage and need for timing certain VIX-ETP participation.

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Disclosure: I am short UVXY, VXX and TVIX

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Jim Bradley 2 years ago Member's comment

Another great article. Truly professional and perfectly detailed! I appreciate your explanation in every way and your ability to give to people. Thank you friend.

Seth Golden 2 years ago Author's comment

Thank you Jim!! Enjoy the holidays and many blessings to you and yours!

Mickey Donovan 2 years ago Member's comment

wow you ramble a lot huh? While your understanding of VIX related products is profound, your explanation is unnecessarily complicated. Also your trading of said product is novice, resulting in poor use of capital.Your returns would be far greater with the use of derivatives, its not for everyone and requires a great deal of study. To be writing articles for the masses to see is a great achievement for you I'm sure, offering such advice you may want to tone down outlandish remarks implying tax reform may not get passed this year because health care reform did not get passed. Such comments is are unproffesional and self serving.

David Lincoln Bechtold 2 years ago Member's comment

Excellent contributor who is the real deal... It is interesting following Stocktwits and seeing how after only a week of vol expansion so many people saying that vol is never going down again and we are in a Bear market and this is the new normal.. As you point out volatility can expand for extended periods and as you experienced in 2015 many people who are really laying into this when it pops blew out. Execution in the real world in real time is very different from talking about things in theory and people have a hard time pulling back from the minute by minute to look at the bigger picture.

I try to get perspective by switching my charts from the 5 minute view to the 1 year view when we have a big move or spike. This helps me regain perspective. Trading through that period from 2000 -2002 also helps me now to think big picture. Thank you for your bravery in discussing your childhood and personal stuff..

-Dave (aka Famisdave)

Seth Golden 2 years ago Author's comment

StockTwits is definitely an interesting place. It can be both beneficial and dangerous at the same time. It really depends on the involvement of the participation and the expectations. Thank you for your participation Dave and reading my material! Have a great Holiday season and be well!

Barry Hochhauser 2 years ago Member's comment

Good read.

I like StockTwits a lot but definitely agree with you. Anonymity can be dangerous. I appreciate the content here where only the best are accepted as contributors and they stake their real name, face and credentials to add credence to their opinions. To me, that's more valuable than the faceless, nameless masses on StockTwits.

Seth Golden 2 years ago Author's comment

Well said Barry and thank you for taking the time to read the article!