A ‘Simple Hedge’ as Market ‘Bumps it’s Head’

  • SumoMe

The S&P 500 has “bumped its head” in a clear resistance level.  The VIX Index has dropped into a familiar support level.  Is the party over?  I hope not.  I would love to see the stock market keep heading higher.  But hey, warning signs are warning signs right?

(See also The U.S. Dollar and The Line in the Sand and The Value of the ‘Perspective’ Indicator)

So should we all panic?  Not necessarily.  Still – and fortunately – there is a difference between “being panicked” and “being prepared”.  So let’s talk about a simple hedge “just in case” the stock market decides to sell off in the not too distant future.

Figure 1 displays ticker SPY with a fairly obvious resistance range highlighted. As the verbiage on the chart asks, “will you be surprised if the market pauses or worse here?”1Figure 1 – Ticker SPY at in resistance zone (Courtesy AIQ TradingExpert)

Figure 2 displays ticker VXX (the ETF that ostensibly tracks the VIX Index).  From a completely and entirely subjective point of view it can be argued that the VIX is in “the calm before the storm” mode.2Figure 2 – Ticker VXX at support zone (Courtesy AIQ TradingExpert)

Figure 3 displays that the implied volatility for options on ticker VXX has fallen significantly and that VXX options are relatively cheap.3Figure 3 – VXX option implied volatility has fallen hard (Courtesy www.OptionsAnalysis.com)

So what about buying the June VXX 16 call for $200 as a hedge against the stock market suffering a hit between now and June option expiration?

Figure 4 displays the particulars and Figure 5 displays the risk curves.4Figure 4 – VXX June 16 call (Courtesy www.OptionsAnalysis.com)5Figure 5 – Risk curves for VXX June 16 call (Courtesy www.OptionsAnalysis.com)

Summary

As always I am not “recommending” this trade I am simply pointing out that several factors (S&P at resistance, VIX at support, option premiums relatively low, and don’t forget “Sell in May” which is just around the corner) may be coming together to make considering a hedge a reasonable idea.

The questions to ask yourself are:

*Do I think there is a chance/likelihood that the S&P will suffer a selloff in the next 7 weeks or so?

*Am I willing to risk $200 if it doesn’t?

 Jay Kaeppel

 

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