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RIP to My Favorite Trade of the Decade

tiny coffin with rip on it amid bed of one hundred dollar bills

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By    |   Thursday, 20 December 2018 10:50 AM

Come January, my favorite trading vehicle of the decade will close. Since its inception a decade ago, it’s lost a staggering 99.9 percent of its value.

So why has it been my favorite trade? Because time and again, I’ve been able to short it when conditions are ripe.

The trade going away is the iPath S&P 500 VIX Short Term Futures Exchange Traded Note. That’s a mouthful, so I usually refer to it by its ticker symbol, VXX.

Why is this fund going away? It’s designed to. As an exchange-traded note rather than an exchange traded fund, it has a limited shelf life, akin to how a bond comes due.

Designed to follow a basket of short-term volatility futures contracts, this fund proved to lose value over time for one simple reason: like options, futures contracts lose value over time as the contract date nears. By continually having to roll its contracts forward, the fund was guaranteed to lose money just about all the time.

So why would investors own such a thing? When they expect the market to drop and volatility to rise, this fund could provide some fantastic short-term returns. A 2 or 3 percent down day in the market (before this year at least), would see the VIX soar by at least 8-10 percent. That’s a nice, simple way to hedge your long side risk with a trade on the short side.

And, given the fact that the fund started operations in January 2009, well, the world was a different place. This was exactly the kind of fund that would lure investors in the final stages of the market collapse of the Great Recession. And given how the stock market didn’t finally bottom and start heading higher until two months after this fund was launched, the real winners here were the original owners who sold off the fund and can now buy it back for less than a tenth of a penny on the dollar now that it’s time to close out.

As I’ve shared with folks over the years, most notably in my book of investment case studies, Safe, Debt Free, and Rich, shorting volatility can be a great trade.

Of course, your risk matters. Many folks also thought the short volatility trade was a surefire path to riches. It isn’t. It needs to be used strategically. Volatility has had an easy run for most of the VXX’s existence. In its final year, and even after losing over 99 percent of its initial value, the fund is actually on track to rise in 2018 thanks to higher market volatility.

And leveraged volatility funds—which are derivatives of the derivative of volatility itself—caused many investors to blow up back in February on a mere 10 percent correction in the overall market.

But for shorting volatility after one of its brief spikes up like an EKG machine, it’s been a surefire way to make money over time as short trade. And with the options that trade on VXX, investors like me have been able to swoop in time and time again, short it, and watch my wealth grow back faster each time the market has pulled back.

So, yes, I’ll miss the easiest short trades of my life. But there’s always another investment that’s structurally designed to lose money most of the time. And there are other and better ways to hedge your portfolio, such as a strategy of selling covered calls against your holdings.

For today’s choppy markets, make sure you protect your wealth somehow—but also consider that the recent market selloff hasn’t moved the Volatility Index as high in the past. That suggests the market is starting to expect wider daily moves, but that this recent selloff is largely overdone.

Happy trading, and have a happy holiday season!

Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.

© 2019 Newsmax Finance. All rights reserved.

   
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AndrewPacker
For today’s choppy markets, make sure you protect your wealth somehow—but also consider that the recent market selloff hasn’t moved the Volatility Index as high in the past. That suggests the market is starting to expect wider daily moves, but that this recent selloff is largely overdone.
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2018-50-20
Thursday, 20 December 2018 10:50 AM
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