To OTC Journal Members:
 

Testing The Theory: The VIX Cooperates For A Trade

The market cooperated today and gave us an opportunity to test the idea I shared in the mid week edition- The idea of using the VIX index to measure extreme levels of fear and complacency, then using those extremes levels to place a bet that the pendulum will swing back the other way in short order.

Here's a kind of crude chart I whipped together. The QQQQs (ETF for the NASDAQ COMP) are shown with the yellow line. The VIX is shown in by the red and green bars. As you can see, when there is a big separation, they tend to want to move back towards each other.

Today, the market opened rather benignly, then the proverial s*** hit the fan. As it turns out, Wall Street Institution Bear Stearns (NYSE: BSC) is unable to meet its liquidity needs and settle trades properly. The FED, through Bear's clearing firm- Morgan Stanley, is going to bail them out for 28 days. BSC was rewarded with a drop from $55 to $30 almost immediately. The stock is firming a bit as I write this edition.

As a result, the market absolutely tanked, and the VIX shot up north of 30 (my benchmark for going long), which indicates investors can't buy puts fast enough to bet on further declines.

I believe you can make a lot of money betting against the crowd when there are knee jerk, emotional reactions. 

I'm testing my theory by putting my money where my mouth is today. I picked up 50 QQQ.DPs- the April 42 calls, for which I paid $1.97 (total investment of $9850).  If QQQQ rises $1, I would expect these calls to rise about $.50- about a 25% ROI.

I won't stay in this trade long if the market keeps tanking, but one small piece of good news on Monday should send the market back into rally mode. This is not some sort of long term call on the improving health of the market- it's just a bet - I'm trying to scalp a few bucks off what I believe is a knee jerk reaction to something already priced in.

Who knows what will happen on Monday and Tuesday. I wouldn't pay more than $2 for those options if you read this later. I posted the trade immediately in the BLOG, and I will post the results when I close out the position.

If you're not getting these trades in a timely manner, check back at the home page on the right hand menu bar, or use the RSS feeds I suggested in the February 23rd Edition. 

If you want to learn more about trading these kinds of options, I suggest calling your brokerage firm for more information. Another good resource for Options Trading 101 can be found at http://www.option-trading-guide.com/.
 

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