In a mid-June Barchart article on the VIX index, I wrote:
The turbulent economic and geopolitical landscapes could cause the stock market to fall in the blink of an eye. Given the range since 2008 and the current level, risk-reward dynamics favor the upside for the volatility index.
The VIX was at 12.40 on June 12, with the S&P 500 index settling at 5,421.03. Since then, the leading stock market benchmark has risen to a new record high, and the VIX has pulled back to around the 12.25 level before rallying to over the 15 level. With the potential for a very volatile second half of 2024, the VIX remains inexpensive, but any long position requires careful attention to risk-reward dynamics. The ProShares Ultra VIX Short-Term 2X Futures ETF product (UVXY) is a short-term leveraged trading tool that could offer significant rewards for disciplined traders with their fingers on the pulse of markets.
Uncertainty is the bull market’s worst enemy
Investors embrace a stable environment and often panic when uncertainty descends on markets. While the U.S. domestic and geopolitical landscapes are in turmoil, investors and traders have mostly ignored the potential for negative surprises, approaching stocks with bullish blinders throughout 2024.
The wars in Ukraine and Israel continue to threaten world peace and escalation, and the bifurcation of the world’s nuclear powers presents a dangerous landscape. The U.S. remains the world’s richest nation with a powerful defense. Future economic, social, and foreign policy paths will be on the ballot in the November presidential election.
The Democrats will now likely nominate Vice President Kamala Harris, while Republicans have chosen former President Donald Trump for a second term. Since the July 13 attempt on the former President’s life, the incumbent President stepped down and will not run for reelection. The bottom line is U.S. political uncertainty is at the highest level In decades.
The candidates will continue to disagree on foreign, social, and energy policy paths. Another four years for a Democrat administration will mean continuing the current political course, while a second term for former President Trump will mean a significant policy reversal.
If market participants dislike uncertainty, you would never know if you looked at the leading stock market indices, which have rallied to or near all-time highs.
Aside from the U.S. election and geopolitical threats, U.S. debt at nearly $35 trillion, concerns over the future solvency of U.S. social security and Medicare programs, inflation above the Fed’s 2% target, and the recent rise in unemployment to 4.1% are issues that could derail the stock market rally. Moreover, the U.S. is divided along political lines, and the divisions have become far more pronounced over the past years, with emotions increasing each year. After the election, around half the country will be disappointed and angry with the result.
October is a historically volatile month for stocks
Uncertainty over the U.S. election will peak in October as early voting begins, and Election Day is Tuesday, November 5. October has a long history of being a month when the stock market can experience extreme pressure.
October was the month of the Bank Panic of 1907, the Stock Market Crash of 1929, and Black Monday in 1987. With the leading indices in record territory, the potential for a correction is rising. The uncertainty of the upcoming election only exacerbates the potential for stock market volatility, and October is always a dangerous month for the leading stock market indices.
October 2024 could be a wild ride
The shots that rang out at a Pennsylvania rally for former President Trump missed throwing the election into turmoil by less than an inch. The wounded former U.S. leader had the presence of mind and body to reassure his supporters and create one of the most iconic images in U.S. history, raising his fist in defiance as the Secret Service ushered him off the stage. President Biden’s passing the political torch to his Vice President changed the shape of the election in a blink of an eye.
Around half the country will not be happy if the Vice President wins and the other half will be unhappy if former President Trump wins the contest. The election rhetoric will peak in October when the stock market historically experiences the most volatility. Simultaneously, the many issues facing the U.S. and world could take center stage in October. The most significant volatility could come from any other unexpected events, as we witnessed with the 2008 global financial crisis, the 2020 pandemic, Russia’s 2022 invasion of Ukraine, and recent events.
Implied versus historical volatility- A long position in the VIX is contrary to the current sentiment
The VIX index measures the implied volatility of put and call options on the S&P 500 stocks. Historical volatility measures the past price variance, and implied volatility is a sentiment indicator that measures the market’s perception of future volatility.
Options are price insurance, and the demand for puts and calls tends to increase during corrections. Just as hurricane and flood insurance prices rise during and immediately after devastating storms, put and call options explode higher when stock prices turn south. Human nature drives market participants to insure risk positions at the most disadvantageous time when panic descends on markets. The primary determinant of put and call options is implied volatility.
Option prices fall when stock prices rise as bullish sentiment leads market participants to sell options to enhance income through covered calls and put writing strategies, causing the VIX to decline. Option prices rise during market panics as participants throw in the towel and sell stocks or purchase options, which are price insurance contracts.
The chart shows the VIX’s price spikes: an 89.53 record high during the 2008 global crisis, 85.47 during the 2020 global pandemic, and 38.93 as the war in Ukraine was getting underway. The VIX’s price is correct at below 13 in mid-July 2024 because it reflects the price of put and call options on S&P 500 stocks, which continue to make record highs. The VIX reached a record low of 8.56 in November 2017.
UVXY can be a valuable tool for disciplined traders
The VIX is telling us that market sentiment remains bullish for stocks. With the Fed moving towards rate cuts after the latest U.S. June jobs, CPI, and PPI data, lower rates tend to lead to higher stock prices.
Meanwhile, market participants continue to ignore the geopolitical, economic, and U.S. political landscapes as the election moves closer daily.
The VIX’s price is the correct price, today. Tomorrow could be another story. The fund summary for the ProShares Ultra VIX Short-Term 2X Futures ETF product (UVXY) states:
At $24.46 per share, UVXY had $223.35 million in assets under management. UVXY is a liquid product, trading an average of over 6.66 million shares daily. The leveraged ETF charges a 0.95% management fee.
The long-term chart dating back to 2011 highlights the extremely high price of the leverage. UVXY has a long history of reverse stock splits.
The bottom line is that UVXY is not an investment tool but can be extremely valuable for short-term trading purposes. Today, UVXY is a contrarian approach to the VIX and S&P 500, requiring strict attention to risk-reward dynamics and discipline.
Those seeking long exposure to the VIX over the coming months can purchase the UVXY product with tight price and time stops. Accepting and expecting small losses from disciplined trading in the quest for oversized rewards if the current environment suddenly sends the S&P 500 plunging over the coming weeks and months could be the optimal approach.
If a selloff begins, a long position in UVXY will offer leverage but remember to increase profit horizons while raising stops to protect capital and profits. The VIX is not too low today, but it could be tomorrow. Sentiment in stocks is like the wind, and we could be in the eye of a very volatile storm over the coming weeks and months. The best time to prepare for a storm is long before it makes landfall.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
