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Something is up.
Something's happening with the VIX – the "Fear Index" – and I think it's going to be big.
Now, I can tell you from experience, this stands a good chance of bushwhacking investors who aren't ready for it, but I also know that if you're ready with the right strategy and the right trades, you'll clean up.
Let me show you what's about to happen – and exactly what to do about it…
Here's What's Coming for the Market
If you're not familiar, the VIX, very briefly, is a measure of the market's expectation of price changes on the S&P 500 index over the next 30 days. It's complicated – I could take a few days and explain exactly how it's calculated, but what most investors need to know is the VIX is an excellent at-a-glance measure of sentiment… particularly "fear."
When I talk to new investors and traders, I find it helpful to compare the VIX to a traffic light: If it's red, the VIX – and fearful sentiment – are likely to drop.
Yellow? Expect a strong move in either direction, so slow down and get ready. That's about where we are today.
If the light's green, expect the VIX and fear to plow upward and onward at full speed.
When the broader market's rising, the VIX usually falls because – hey – who's afraid of rising stocks, right? When prices are falling, the VIX usually rises because investors are so worried they're shuffling money around, making protective moves. When investors realize that the VIX is rising, particularly in a market that's up 13% year to date, they can flat-out panic.
Like I told Jim Cramer on CNBC's "Mad Money" the other day, volatility usually moves or manifests itself in a few very different ways. Each "flavor" presents different opportunities and different dangers.
There are volatility "surges" that can happen every day thanks to the 72 million new investors and traders who've hit the markets. Those can represent significant opportunities – there's more on that here.
Then there are the volatility "spikes," where some event freaks investors out, creating a sell-off that lasts a session or two. This kind of volatility, though it can be scary until you've been around the block a few times, usually resolves itself pretty quickly. These spikes can be outrageously profitable if you trade them correctly, whether you're talking inverse or leveraged inverse exchange-traded funds (ETFs) or VIX options. Heck, you can even do well during a spike if all you've got is a "Buy" list of targeted stocks to grab at a discount; it's the classic buying opportunity.
Then there's the volatility "swell." This one's a little trickier.
A swell unfolds when volatility and the broader markets rise together or volatility rises in a flat market. A swell indicates a bigger, more lasting move could be in the works.
And that is what you see when you do a simple chart of the S&P 500 and the VIX. That's what's been happening over the past month.
It's calmer today; the VIX is below 19 but above 17. It's up more than 5% for the month and beginning to creep back up. I wouldn't rule out a swell until the VIX falls below 17 or less and stays there for a few sessions. But until I see that happen, I'm not ruling out a VIX run to 30 over the next few weeks.
"Ok, great," you say, "volatility could swell. What do I do about it?"
Well, like I said earlier, it's easy to cash in when markets get this way…
How to Profit on a Rising VIX
Now then, when the market goes down (and volatility goes up), some people think this means it's time go all-in and "short the market," or load up on inverse or leveraged inverse ETFs. That's a misconception – one that can cost you big-time.
Get a firm grasp on your risk tolerance and think about buying put options on the SPDR S&P 500 ETF (NYSEArca: SPY) instead. For one, you can take small positions – "wet your beak" and manage your risk while still remaining long where you think it's prudent. Watch those positions closely, and if the market drops – as seems likely – and they start to pay off, think about getting more aggressive with it. And keep your "Buy" list of stocks you want to own at a discount handy.
I'm also looking at a big impending reverse split in one of my new favorite leveraged volatility plays. How big? Like $4 to $40 overnight "big." This ETF tracks short-term volatility on VIX futures, and it's going to be possible to cash in no matter which direction volatility moves.
I'm updating my free Profit Takeover subscribers with all the details on this ETF on Thursday at 2 p.m. Eastern. We're going to look at how to turn this split into fast, consistent asymmetrical returns. Click here to register for my "webinar" – again, it's totally free. And if you already get the Profit Takeover, sit tight. I'll be in touch.
The bottom line is, if you're a trader, volatility is really nothing to worry about. Once you get used to it, you can see if for the profit opportunity it really is.
Tom Gentile, my colleague, has been watching the volatility generated by the surge of new investors over the past year or so. He's found that, yes, there's definitely profit potential in that volatility. Tom back-tested some of these events with this BRUTUS algorithm and uncovered chances for 300% returns in three days… 650% in eight days, and even 2,500% in 14 days over the back-testing period. That's how great volatility can be – you can go here to hear it from Tom himself. I'd encourage anyone to check out his volatility "surge strike" research.
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