Friday, August 13, 2010

The Tale of the VIX and Mr. Upper B.

After a six week absence, the VIX has once again decided to pay a visit to its dear old friend Mr. Upper Bollinger. On the tails of a rapid two day 4% plunge in the S&P 500 Index and the constriction of Bollinger Band width, the encounter shouldn't be that surprising to those monitoring the touch and go relationship between these two pals.

Come to think of it, perhaps I've got part of this metaphor all backwards, as these two completely inanimate variables which I'm so heartily trying to anthropomorphize aren't so much friends as they are enemies. It seems they are hardly ever comfortable residing in the same location at the same time. Matter of fact, with the recent exception of May, virtually all of their confrontations turn into short lived skirmishes ending with the VIX returning, often speedily, to its home between Mr. Upper and Lower B. Consider the following chart highlighting the last ten run-ins of these two foes (click to enlarge).

[Source: MachTrader]

With yesterday's exhaustion gap on the S&P 500 and subsequent pop in the VIX, might it be time to bet on a bit of mean reversion? Given the VIX's historical tendencies, it seems we have probability on our side. With August expiration for VIX options comin' round the corner, front month options lend themselves to some interesting short term plays. How about selling an Aug 27.50-30 bear call spread for $.50? Risking $2.00 for a $.50 payout over three trading days isn't too shabby in my book. Provided the VIX settles below $27.50 next Wednesday morning, both calls should expire worthless resulting in the realization of max profit. But, who am I kidding. I never ride to expiration so I'd likely bail upon capturing the majority of the gains.

Those convinced the VIX's little run in with Mr. Upper B is likely to linger would obviously want to pass up the play. On the other hand, if you think the market sell-off is due for a pause or perhaps a bit of a rally back, this may be a strategy worth considering.

For related posts, readers can check out:
VIX Options
Settlin' Them VIX Options
A Volatility Inflection Point
Lessons Learned From a VIX Put Matrix

2 comments:

Anonymous said...

Tyler,
I often here rookie traders talking about Penny stocks. I've always been encouraged to steer clear of them for a few reasons, but i've never really talked with another experienced trader in depth on exactly what all the pros and cons of trading penny stocks. I'm sure it has something to do with the liquidity and how accurate certain analysis is in comparison to more actively traded stocks. What is your take on penny stocks?

Thanks,
Chris

QUALITY STOCKS UNDER 5 DOLLARS said...

A nice clear look at the markets.