Volatility (VIX, VXX) has had an inverse correlation to the market. As the market rises, volatility declines, the inverse has been true for market declines. With the daily headlines about tax reform and this week's new all time highs in the Dow and S&P, you would expect for new lows in volatility measures. But no, as you can see in this VIX chart, volatility is flat to rising. We are taking note of this divergence with a new trade.
We are adding UVXY (Leveraged via 2X VXX) to the Special Situations Portfolio. This will be a shorter-term and highly speculative trade in expectation of a reversal in the trend of market volatility. We're capping risk at 10%.
We don't need options here, the stock/ETF is leveraged enough. Even a mild downturn in the markets could cause this index to rise 50% to 100% in a matter of days to weeks. By holding the ETF shares outright instead of options there is no time erosion working against the position. This allows us to wait for the volatility to come to us. Once volatility starts to trend up, it will do so quickly and I'd rather get in a little early and wait out any slight drawdowns, than have to play catch-up in a rapidly moving market. As with all Special Situation trades, this trade is based upon risk:reward considerations, where the former is highly outweighed by the latter. Accordingly, we are capping risk at 10%.
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