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Lower volatility means higher stock prices right?

I mean, that’s what we’re told. After uncertainty got sucked out of the market, this is one factor I believe it’s important to focus on.

Right now, I’m not cheering on the nosedive in the S&P 500 volatility index known as the VIX…

Because it’s coming into support which could stop the rally dead in its tracks.

Which is why I’m actually betting against one stock in particular for my Bullseye Trade of the week.

I’m not saying we’re about to see stocks crash.

But the ‘Johnny come lately’ traders might get sucked in at the top, only to have the rug pulled out.

So, I’m going to show you how to avoid that mess and protect yourself.

And make sure you aren’t left on the side of the road

Two key levels in the VIX

For those of you who aren’t familiar with VIX (and even if you think you know all about it), let me give you a quick refresher.

The VIX is an index which measures options demand on the S&P 500.

In general, investors buy put options on the S&P 500 to protect themselves against declines. Since these funds hold various stocks in their portfolio, these puts act as insurance, letting them sleep safe and sound at night.

When you read the VIX, the number tells you the implied move for the S&P 500 over the next 30 days stated as an annualized number.

For example, a reading of 24 means the market expects the S&P 500 to move 24% higher or lower if you annualized the move over the next 30 days.

What’s interesting is that while you can’t trade the VIX, you can buy options on the VIX as well as futures.

So, you wouldn’t think that normal support and resistance levels work.

But in fact they do!

Check out the following chart of the VIX

VIX Daily Chart

The solid black lines identify two key support areas for the VIX at $22 and $24.50.

How did I come up with those?

Notice how the bottoms of the candlestick wicks (those thin black vertical lines) seem to congregate around this area.

This visual representation of price action says that when the VIX traded down to around $24.50, it would stop and turn higher.

The same thing happened at $22.

See how many times price got to $22 and failed to drop below?

That signifies a key price level in the VIX.

You’re probably asking, so what, why should I care.

Maybe you’ve heard the VIX called the ‘fear gauge’ before. That’s because investors often buy put options on the S&P 500 when they fear markets going down.

And quite often, smart money does this anticipating a decline.

That’s why the VIX and the S&P 500 tend to trade in opposite directions.

And it’s a big reason I use it as a leading indicator.

So, if I expect the VIX to bounce off key support levels, that means I believe stocks will turn lower.

Trade ideas

WIth this information in mind, I want to give you a couple ideas of trades I like to play in this scenario.

First, I like call options on the VXX and UVXY ETFs. The VXX tracks VIX futures with 1x leverage. The UVXY does the same thing, but with 1.5X leverage.

While these ETFs lose value over time due to their structure, they are great trading instruments. And when you see swift pops in the VIX, it often leads to outsized moves in these ETFs.

Compare this daily chart of the VXX to the one for the VIX above and you’ll see what I mean.

VXX Daily Chart

You can also see how the value naturally declines over time.

Time these right and you could get a run like late August that went from $23.64 to $34.08, or 44% in just a matter of days!

And that’s just what the stock did. Imagine how much the options moved!

Want to hear the best part?

When you think the VIX has peaked out you can buy put options on these same ETFs and ride them down for a profit!

Now, if you’re unsure of how to trade options, not to worry.

I’ve got you covered.

Here’s a link to my Ultimate Guide to Options, chock full of valuable information and insights to get you on your way.

Click here to access my Ultimate Options Guide

 

Author:
Jeff Bishop

One of the best traders anywhere, over the past 20 years Jeff’s made multi-millions trading stocks, ETFs, and options. He is renowned as an incredible trader with a deep insight and a sensitive pulse on the markets and the economy. Jeff Bishop is CEO and Co-Founder of RagingBull.com.

Even greater than his prowess as a trader is his skill and passion in teaching others how to trade and rake in profits while managing risk.

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