Trading Volatility for Quick Profits

July 12, 2024

The CBOE Volatility Index – the VIX – is known as the fear gauge.

When investors are scared, the VIX goes up… and when they’re comfortable, or even complacent, the VIX comes down.

Simple, right? So simple, in fact, you can trade this action in both directions… for quick profits.

I’ve spent the past few columns talking about how to use implied volatility to trade calls and puts.

Now we’re going to look at how to trade volatility itself… with the VIX.

The VIX measures the implied volatility of the S&P 500 (SPX) for the next 30 days.

That implied volatility typically rises when markets are rocky… and comes back down when stock prices are in an upward trend.

In March 2020, as investors grappled with the COVID-19 crisis, the VIX reached an all-time high of 82.69.

And this year, with the S&P 500 hitting dozens of all-time highs, the VIX spent most of June between 11.87 and 13.90.

In the chart below, you can see that VIX readings below 15 show optimism, while readings above 25 point to fear.

Source: S&P Global

Doesn’t get much simpler than that. So here’s how you can trade it…

A Key Difference

The first thing to understand about the VIX is that it is not a stock. It’s a temporary indicator of market sentiment over the next 30 days.

Unlike a stock, which can climb higher and higher over time, the VIX trades in a range until something happens to make it spike higher (a global pandemic… a financial crisis… a banking crash… etc.).

And just as fast as it spikes, it typically plummets. What made it spike becomes priced in… or investors are no longer scared.

As you can see from the following one-year chart of the VIX, nearly every spike to the upside has been followed by a quick pullback – even if the pullback is temporary.

Source: Bloomberg

Something spooks investors and the VIX jumps… and then investors adjust to the current market condition and the VIX comes back down.

So we’re looking at short trades here.

I like to wait until the VIX hits a significantly low reading and then buy call options – or better yet, a call spread – with a short expiration, between 15-45 days out.

On the flip side, when the VIX spikes above 25, I like to buy put options (or a put spread), again, with a shorter expiration.

Of these two types of trades, buying call options when the VIX is low has worked out pretty well this year.

Source: Bloomberg

Over the last 12 months, each time the VIX has gotten down to 11.75, we’ve seen a quick spike higher. Trading each of those spikes could have made a quick profit.

The VIX at 11.75 has seemed to be the point at which investors have become most complacent, which has given way to some fast spikes higher.

Here are two examples…

After the VIX traded down to 12.66 on March 27, investors who bought the VIX April 15, 2024, 13 call could have made a quick 247% just 12 sessions later.
And when the VIX traded down to 11.86 on May 21, investors who bought the VIX June 12, 2024, 13.5/14 call spread could have made a quick 400% closing their trade on May 30, just six sessions later.

And in my Alpha Money Flow trading service, we’re currently in a VIX call spread trade that expires next month. I’ll be sure to let you know how the trade works out.

The key to any potential VIX trade is to be patient. Wait for the trade to come to you at a level that increases your odds of success. It’s far better to sit on your hands than to throw good money after bad trying to guess every micro-sentiment in investors mindset.

It is, after all, called the “volatility” index for a reason.