“Twenty years from now you will be more disappointed by the things you didn’t do than by the ones you did.” — Mark Twain
Nothing like a 300-point swing to light up the volatility index.
That’s pretty much what happened last Friday, as the Dow Jones Industrial Average (DJIA) started the day with a nice little 70-point gain in the morning.
From that point on, however, investors seemed to lose their appetite for equities, as the Dow trended steadily downward for the remainder of the day.
Steadily, that is, until the last 15 minutes of the trading session, when a sharp drop ensued as sellers proceeded without any noticeable resistance into the close, leaving the Blue-Chip average off nearly 100 additional points.
At the closing bell, the Dow ended the day down 1.36%, not a terrible number, really, particularly considering the outperformance of the equity market so far in 2013.
Still, the way it ended could offer up a red flag to the Bulls, who have probably developed a serious degree of complacency due to the healthy year-to-date gains in all three major indices.
The bottom line for the week — the Dow fell 1.2%, the benchmark S&P 500 Index (SPX) shed 1.1%, and the Nasdaq (COMP) lost 0.1% over the course of the holiday-shortened, four-session period.
The market still outperformed for the month of May, as the Dow climbed 1.9%, the SPX gained 2.1% and the tech-laden Nasdaq added a nifty 3.8%.
But that finale on Friday made it hard not to at least think about the famed rhyme “sell in May and go away.” Whether that turns out to be the smart play or not remains to be seen. But it may become visible within the next couple of months.
The volatility that has returned to the market in a pronounced way since the Boston bombing should be considered an indication of a shift in investor sentiment towards the market.
Certainly, for the majority of 2013, a certain level of robustness has been illustrated, as evidenced by overall market reaction to any mediocre and weak news that happened to appear. Investors gave the benefit of the doubt to equities time and again, and the year’s uptrend remained firmly in place.
The recent increase in volatility levels, as represented by the Chicago Board Options Exchange Market Volatility Index (VIX), known as the “fear gauge,” may be seen as indicative of this shift, though not necessarily one to be viewed as a leading indicator.
Back in March of this year, the VIX hit 11.3, its lowest levels since the 2008 crash. Since then, however, it has ranged about 20-30% higher, with Friday’s close shooting up beyond even that level, all the way up to 16.3. (Worth remembering, of course, is the fact that the VIX generally goes up as the market goes down, and vice versa.)
So how do you tap into volatility as a way to hedge your portfolio? Surprisingly, there is really no simple answer for most investors who generally don’t have the stomach for playing the futures market, where options on VIX futures remains the most pure of the volatility plays.
Therefore, the most comfortable volatility vehicle for many investors and traders to use is an ETF, one created around the VIX. And, while all of them have severe limitations in terms of serving as portfolio hedges, VXX (S&P 500 VIX Short-Term Futures ETN) is relatively the best of the lot for the purpose. VXX tracks the S&P 500 VIX Short-Term Futures Index Total Return.
Consider adding the VXX to your portfolio as insurance against the inevitable correction that could materialize long before the summer ends. However, remember that it is indeed insurance, and as such you will be paying a premium if the market continues its uptrend, or even if equities trend sideways for an extended period.
ETF Periscope
Full disclosure: The author does not personally hold any of the ETFs mentioned in this week’s “What the Periscope Sees.”
Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into account their personal financial circumstances in acting on any rankings or stock selections provided by Sabrient. Sabrient makes no representations that the techniques used in its rankings or selections will result in or guarantee profits in trading. Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results.
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