"Alpha isn't found in the market; it is created by interaction with the market." -Euan Sinclair
Alpha is elusive to most folks. Not a lot of people get it, and those that do, are often not the most eager to show others how when they are trading at an institutional level. Often, those getting alpha today, are those lagging in performance tomorrow. We want to avoid this fate, and thus are going to hedge our current VIX shorts with a long position. We want to take advantage of the elevated uncertainty around the election. Up and down.
Ideally what we want to do is trade the variance premium and seasonality simultaneously, and sell both contradictory positions at optimal times (or have them expire ITM). If we sell both positions at a gain we will maximize our alpha, but it takes some fancy footwork. But I am confident that with a little elbow grease, we can benefit from both the election volatility flush, and crush.
So our trades thus far have taken advantage of the variance premium, or the fact that implied volatility tends to be higher than realized volatility. This is the tendency in markets, but there are also seasonal periods where implied volatility and realized volatility tend to be elevated. We are entering such a period, although the beginning of September is actually pretty quiet historically. The VIX is entering a seasonally volatile period on the back of S&P seasonal weakness, and the negative correlation of the VIX and the S&P 500 is particularly strong during the Autumn months as well.
So far, at Punk Rock Traders, we have had an auspicious start to our VIX trading column, Black Swan Party. We have recommended three VIX positions so far, and their performance has been impressive over a short period. They held up despite a VIX spike in the mid $16 handle.
Nov. 20 $23 puts recommended on 8/6 are up 46%
Nov. 20 $18 puts recommended on 8/13 are up 33%
Sept. 18 $15 puts recommended on 8/27 are up 12%
These trades are doing well as of Friday's close, and you can also see that when you play with the contracts with less time value. their implied volatility can fluctuate quite a bit faster. We recommended the September 18th $15 puts the most recently, yet have both been up the most, and down the most. While they are only 12% right now, these buckaroos were both down in the double digits and up in the triple digits.
We will continually come back to tenor of less than one month to juke up returns, but always within reason. We are Punk Rock Traders, not lose all your money traders. We try to mix our highest risk trades with other lower risk trades to help balance them and to ensure you stay in the game and don't lost all your money. Many of our trades put you at risk of losing 100% of what you invested.
There is a lot of alpha in the tenor below month, and there are new rules in this market. In some ways this area of the VIX options market is like the Wild West, full of both risk and opportunity. The implied volatility spikes are brutal and if you're not an experienced options trader these contracts can cause you to gnash your teeth.
If you bought the September 18th puts, you know how volatile short dated VIX options can be. That is why we solidified the position in longer dated November options whose implied volatility moves more predictably and in a more stable fashion, for the time being.
I want to be clear that I am not changing my generally bullish disposition on markets. Volatility tends to cluster more during bear markets than during rallies. Therefore, other than some seasonal turbulence, which I think will be short and not too sharp, I think we will be in for a bull market melt-up environment with low volatility. I expect volatility in October to be elevated both for typical seasonal reasons and because of the election.
Therefore I am recommending you buy the October 16th, $16 $VIX call option currently trading at $2.50.
This will act as hedge against the three short positions I have recommended throughout August.
I expect a volatility spike around the first week of October in line with seasonal election-year trends.
I expect uncertainty around the election to build into the next few weeks, but ultimately expect a large post-election volatility crush. No you can benefit from both the runup and the crush.
I know, I know. I am recommending a long VIX position which is somewhat out of character for someone with a theory on why the VIX is suppressed. But I have gotten you so short the $VIX over the past few iterations of this note that you could fall into your loafers. However, in my defense I did get you short the $VIX beginning on August 6th and took advantage of the largest volatility crush in the history of the index.
Bears make a living, bulls get rich, and pigs get slaughtered. So, I am adding a long $VIX position expiring into October, which coincides with the weakest period for the S&P 500 and the strongest period for the volatility index. Ben Turcan did a great job of explaining the seasonals in Punk Rock Technicals. He also gave us a perfect target for going long the VIX, given his detailed work on seasonals.
The most likely week for a VIX spike, given election year seasonality, is the first week of October. Given that we have had such a precipitous collapse in volatility since August 6th, I think it makes sense we some reversion in line with seasonality. I really enjoyed the first installment of Punk Rock Technicals because not only did Ben Turcan explain seasonals in historical context, he also extrapolated on a reasonable cause for seasonal weakness: taxes. The middle of September is the final quarterly corporate tax payment.
Getting alpha requires dexterity. Seasonality and the variance premium are both ways traders can capitalize on volatility. There's no reason that you can't do them at the same time. My short VIX trades have been successful, and I don't want to jeopardize their gains by not jumping on a clear pattern of election-year seasonality. Happy trading to all of you, Punk Rock Traders!
