Signal Du Jour - survive the spike.

VIX 50

Markets are tumbling in the continuation of the moves observed last Friday. VIX is currently trading around 60, while the SP500 futures point toward a -3% at the open. The Nasdaq is (so far) off the lows we’ve seen during the European session. However, who knows what exactly will happen during the American Open: Will it follow the Japanese lead or pair back some of the losses?

The only correct answer at that stage: nobody knows.

It may be tempting to jump on the wagon and start buying everything or short anything VIX-related in fear of missing out. We are still in the middle of (quite) the spike. Therefore, it is best to stay on the sideline and manage all the positions already open to the best of your abilities.

Most of the signals we’ve given over the past two weeks are now completely underwater. It happens, but reasonable sizing should have made an annoying problem, manageable nonetheless.

These positions are now all delta 1. If you decide to keep them, you hope the market will revert. “Hopium is a hell of a drug for retail traders. We seriously advise against it, and to quote my favorite author, “That money is already gone. Forget about it.”

When we put these straddles on, we wanted volatility exposure. Clearly, our forecasts were wrong, so it is best to get out. Sure, you may have some regret if things come back up, but you will have even bigger regrets if they tank another 5%. And at that stage, nobody knows.

You can keep the deltas if they are not too heavy in your portfolio and are “happy to own the ETF.” Just understand that it is not a volatility trade anymore.

As far as we are concerned at Sharpe Two, we won’t do that and manage the best possible exit. How will that work? Expect some wild bid/ask spread in the options order book. Therefore, the best way to exit these positions is to trade directly the underlying and hedge the straddle’s side in the money: if it is the put, you are long delta, and you want to sell some stock. If it is the call, you are short delta and want to buy some stocks.

Being punched in the face is never nice, but it happens, and the best you can do now is survive it. What comes up must come down, will say the bears, happily feasting on the dead meat. That is debatable for every asset class except … volatility. It will come down at some point.

Be patient; when it is clear that the storm is behind us, trading volatility will suddenly feel much easier and quite profitable.

Happy trading.