I have been watching my little investment in VXX, and it surely has a high inverse relationship to the price of SPY. If SPY falls by $1.00, VXX goes up by $1.00, and vice versa. Next week, I will set up a $10,000 actual portfolio account for us to follow. I will call it the Black Swan Hedge portfolio. Since we know that there should be a downward bias to VXX, we will hedge our hedge bet by selling an out-of-the-money VIX call option to cover the downward bias. VIX could go up by at least 10 points before the short call became in the money. If it goes up by that much, VXX should also go up by a large amount, presumably more than enough to cover the cost of buying back the short call.
Because we will be selling a naked call, this portfolio could not be used in an IRA account. However, you could own VXX in an IRA account and sell the naked call on VIX in a regular margin account and you would have the same positions and protection.
Speaking of this naked call sale, it is an interesting idea. For example, last week I sold 10 VIX March 35 calls for $1.00, collecting $985 after commissions. The maintenance requirement on that sale was $3100, so I have about $2115 tied up in the position ($3100 - $985). If VIX ends up below 35 in six weeks (it was 25 when I made the sale), I would make a 46% gain on my investment for the six-week period. Of course, if VIX goes up over that time, the maintenance requirement will go higher, but since I also own 100 shares of VXX, there will not be any margin loan - the maintenance requirement will be covered by the equity I have in VXX up to 50% of the value of my VXX shares. If VIX does go up 10 points so that my naked call becomes in the money, VXX should have gone up by a large enough amount to protect against a possible loss in the short call position.
You might be more comfortable selling a naked call in VIX at the 40 strike - except for the fall of 2008 and early in 2009, VIX has not been over 40 in the last 10 years (a couple of time it shot up briefly to 40 but retreated quickly). Of course, you would collect less for the 40 call - yesterday, with VIX at 24, an April 40 call could be sold for $.75 - (for 10 calls you would collect $735 after commissions), and you would have $1715 (maintenance requirement $2450 less $735 cash received). That would be a 43% return on investment for 10 weeks. If you also owned VXX as a hedge against a huge market crash, you could feel comfortable that it should essentially never lose money (if VIX shot up 10 points, you might have to sell some of your VXX at a profit and buy back the short calls).
There are many ways to protect against a market crash. While buying VXX and selling a naked call is a little unusual, it is possibly a hedge that will not cost you money over time as most of the other possible hedges are likely to do.
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Major market indices broke their four week long losing streak this past week as the small caps decided to push ahead and finally outperform their big brothers - the large caps. The Russell and NASDAQ gained 3% and 2%, respectively as the tech heavy indices climbed steadily throughout the week and decided to leave Mr. Volatility behind.
Most of the gains came after a potential aid package for Greece was announced on Tuesday.
"The fact that somebody is stepping in and providing some support is great news for everybody," NYSE trader Robert Heller of Chapdelain Brokerage told FOX Business. "We've seen for the past couple of years that everything is global and is connected. It's Greece today but it could be California tomorrow."
The EU show of support was enough to allow the world markets to turn their attention to an upbeat U.S. labor report and rallying commodities on Thursday, which helped to push energy and basic materials stocks higher.
"Commodities have decoupled from the dollar right now... because there is more good news than bad today," said Art Hogan, chief market strategist at Jefferies & Co. "We're starting to see the intuitive reaction to the resolution on Greece and better-than-expected economic data."
As for the labor report, investors were pleased with the better-than-expected weekly jobs report which dropped by 43,000. It was the fewest in well over a month. Economists' had anticipated a decline of 15,000.
With the S&P 500 declining over 7% from its 15-month closing peak on Jan.19 in recent trading sessions, market participants had been patiently waiting for a major catalyst to spur a search for underperforming sectors. Indeed, some of the week's best performers were some of the market's worst laggards in the past four weeks -- including technology, materials and energy sectors. The S&P 500 has now climbed 59.4% since its March 2009 bottom after having pulled back from a run-up of 70% (just a few weeks ago) since that significant low.
As for the technical scene, well, the S&P is notably oversold, but the other major market indices have pushed to near overbought levels which could create a tug-of-war over the next week. The one positive for the bulls is the recent hold of what seems to be strong support levels. As long as the market continues to bounce off of these levels I expect to see a continuation of the trade range with a push to the upper part of the range.
Next week should be quite interesting as many of the markets around the world will be closed for a portion, if not the entire week. In addition to the U.S. markets being closed on Monday, the Lunar New Year has begun in Asia which means China, Taiwan and Vietnam will be closed for the entire week. Furthermore Carnival begins Tuesday (Yes, Fat Tuesday) which means Latin America will be in celebration mode. However, the economic calendar will pick up next week with Industrial Production and the FOMC Minutes from late January are due out Wednesday and CPI comes out Friday. All three combined with expected lower volume could provide for another volatile week for the market. We shall see soon enough.
Andy
Overbought/Oversold as of February 13, 2010
Major Benchmarks