The Contrary Investing Report
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How To Profit From Rising Volatility

by Brett on April 28, 2010

“Be fearful when others are greedy” – Warren Buffett

Earlier this month, the VIX, a commonly used measure of stock market volatility, hit an 18-month low.  We wrote at the time:

As you can see from our experience in 2008, when the VIX breaks out, it breaks out in a big way. So a breakout on the VIX would be a good cue for us to start slamming the PANIC button as hard as humanly possible.

But for now, all is calm in the markets, as February’s drop now looks like a pebble tossed in the pond in hindsight.

The VIX could continue to head lower – who knows – but one would have to expect a spike in our future again sooner rather than later.

During yesterday’s market meltdown, the VIX registered it’s biggest UP day in nearly two years:

VIX volatility chart
Fear is “so 2008″ these days

Chart courtesy of StockCharts.com

One day does not make a trend – nor does it even constitute a breakout.  BUT – it could be the start of something big.

So if you’re a trader, how would you play the potential for rising volatility?  You could “go long” volatility – as Chris Mayer writes in today’s Daily Reckoning:

Conveniently, Wall Street has made fear a tradable commodity. One way to play it is through the iPath S&P 500 VIX Short-Term Futures fund (NYSE:VXX). Though a mouthful, it simply aims to mimic the VIX. It started trading only this year. It’s done horribly, as you would expect given the fall in the VIX.

Yet it could be a nice play should we have another spike in the VIX. If fear should rear its head again, as it undoubtedly will, the VXX ought to prove nice insurance. More than just insurance, it could return three or four times your money, depending on the spike.

The risk/reward of this trade looks very enticing.  For what it’s worth, I’d be inclined to wait for a more decisive break to the upside – because if fear pops, it’s going to pop in a big way.

But it’s definitely a very interesting entry point here to go “long fear.”


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