The Diamonds

In my previous post I made a clear distinction of the relationship between the VIX and the broad market indexes. I consistently trade the DIA (a.k.a. "the Diamonds"), SPY ("the Spiders"), QQQQ ("the Cubes"), and IWM ("the Rut") - I consider them to be the cornerstone of my trading strategy. I am almost always hedged in these instruments and rely on them for steady growth and income. I am also inclined to speculate on individual stocks (usually using options) and partake of some of the "ultra short" products that are around (SDS and SKF are favorites).

Anyway...back to the VIX. The VIX is an index that measures fear and complacency in the market. Basically it is calculated by measuring options activity and plotting it over time. When the VIX is low then there is lots of complacency and everyone is feeling pretty good - the price of stocks fluctuates in a narrow or "normal" range. When the VIX is high there is a lot of fear and so the price of stocks fluctuates widely.

The VIX is a "contrarian" indicator, meaning that it should be interpreted as being inverse to the market. The old saying goes: "If the VIX is low its time to go and if the VIX is high its time to buy". Bearing that in mind, if you look at my previous post and the associated chart you will see that I pointed out the relative "lowness" of the VIX and correlated it to the SPX and DOW. Clearly on May 19th the VIX was saying "time to go". At that time the DOW, S&P, and NASDAQ indices all rolled over and started heading lower. I was mostly in cash so I quickly bought PUTs on the DIA, SPY, and QQQQ. I also went long the SDS and wrote some CALLs against that position. My hedges have been some short term trades of the indexes on the bounces and a couple of stocks (like AAPL) to catch the upside when it occurred. So....I can say that when the VIX whispered in my ear a couple of weeks ago, I'm awfully glad I listened!

Where to now? Good question! My bet is on a continued downward movement of the broad market, although I've substantially lightened up on unhedged PUTs in favor of some complex option spreads. (My trading mantra is "defined risk, positive time decay".) Today's price action and VIX behavior makes the near future look like party time for the bears...but I'm not immune to fear - as the VIX rises so does my concern. This is not a time to be greedy...this is a time to be smart.