No. of Recommendations: 12
Yeah, I know, fiscal cliff, blah blah blah. We're all sick of hearing about it.

I just thought I'd pass on a little observation about the last round of brinksmanship.

The VIX was in the 16-20 range for the first half of July 2011, at which
time the news cycle about the debt ceiling crisis was well under way.
Everybody already knew about it, but it didn't show up in the VIX until very late in the game.
By Aug 20-22 the VIX was sustaining levels over 40.

RSP (the average S&P 500 firm) held steady around $48-50 for the whole of July
but dropped to $40.70 by Aug 9, a drop of 15-19% depending on your start date.

So, despite the current amazing calm in the current index level (S&P 1413)
and implied volatility (VIX 17.0), there is a passable chance that
history will repeat itself anyway: despite everybody and his brother
having known this was coming for at least 18 months, the market might
get very choppy and the VIX might soar. There are quite a few politicians
with extremely strong motivation to be intransigent and go to the brink or beyond.

Though as a general rule I think hedging by buying the VIX is a poor idea,
this might be a not-too-bad exception.
I'd suggest considering buying VIX futures for Jan, Feb, and (maybe) March.
These are trading at $17.15, $18.25, and $19.25.
The downside seems limited—unlikely the VIX will fall sustainably below 16 in this time frame.
The upside seems quite nice, and if it does pay off, there is a good
chance that it will pay off at exactly the moment you want to have
a little bit of spare cash to be buying on those dips.

Each futures contract corresponds to 1000 times the VIX index level.
If you buy a January future at 17.15 and the actual value on expiration
day is 16.15, you lose $1000 per contract.
If the actual level at expiration is 37.15, you make $20000 per contract.

The reason for suggesting different expiration dates is that the VIX
is mean reverting, so unlike index futures the current price of the
futures does not track the current price of the underlying index closely.
The value you pay today is what market consensus thinks the index will
be on expiration date, and on no other date. By taking multiple dates,
you get multiple chances for a contract to be at (or near) expiration
at the same time as a VIX spike. If there is a big spike it will
cause the nearest-expiration contract to move the most, but it will
move the others too, so you could close them then as well.
If/when the spike happens, you'll know it.

Print the post  


What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.