Be Careful Trading VXX and UVXY

From Our August 2015 E-mail Archives: One of our traders had a question about trading volatility. Our Senior Risk Manager, Corey, replied with a detailed explanation of why Maverick Trading trades VXX and UVXY differently than other assets in the market.*


-----Original Message-----

From: Roman F.
Subject: Trade Alerts

Hello,

Thank you for the ideas and updates, I check them every time.

I have one question about today's ideas: VXX. I constantly trade it and would like to confirm something. It looks like it's overbought and reached the resistance levels, but it opened above 17.00 today and still trending above this level. Why did Maverick Trading go long puts for 16.00 (delta 0.31, theta 0.02)? I have entered this position today with long puts at 18.00 (delta 0.51, theta 0.02).

If you have a chance, could you explain it for me?

Thank you in advance,

Roman


-----Reply Message-----

Hi Roman,

Thanks for the question. We trade VXX [iPath S&P 500 VIX Short-Term Futures ETN (Exchange Traded Note)] a little differently than we would most other assets in the market. The reason is that this is a flawed asset that is nearly always on its way to zero.

I have included a chart to the right (click the chart to make it larger) that shows VXX since its first trading day. It appears that the shares first started trading in 2009 for around $6,500 per share.

Did they bring this to market at such an expensive share price? The answer is of course, "No." This simply shows what one share was worth in 2009 compared to what it would be worth today. In other words, for every $6,500 invested in VXX in 2009, it is worth around $17.50 today (a loss of 99% of your investment).

The creators of the VXX reverse split this ETN whenever the share price drops. So, if you bought 100 shares at $100/share, then you have invested $10,000. If the shares fall to $10.00/share, then your $10,000 is only worth $1,000 today. If they come in and reverse split the stock, it won't help or hurt your situation. If they take that now $10.00/share price and boost it back up to $100.00/share ($10 x 10 = $100), then they will divide your share count by 10 at the same time. So, you now will only own 10 shares of the $100/share stock. If the stock falls again and again and again and they keep reverse splitting the stock, then you eventually have fractional shares (and essentially nothing).

The VXX and UVXY [ProShares Trust Ultra VIX Short-Term Futures ETF (Exchange Traded Fund)] work differently than most ETFs. This is due to their not really being able to "own" anything. A stock ETF is backed by shares of the companies that it tracks. Gold ETF is backed by Gold. VXX and UVXY track volatility, which is only a market gauge. In addition, VXX and UVXY have to use the futures to track volatility. Since volatility trades in "contango" (i.e., long-term volatility is a lot more expensive than short-term volatility), this is not a good thing.

To track volatility, both VXX and UVXY have to constantly buy expensive and sell cheap futures contracts. This creates a negative yield in VXX and UVXY that, over time, has them always going to zero (although they counteract this by constantly reverse splitting the shares). You can make money bullishly on VXX or UVXY only when there is a gigantic increase in volatility and even then you might not be able to outpace the decay.

In summary, we would be very careful and suggest avoiding VXX and UVXY as bullish candidates for the reasons above. However, trading them to the downside can be very advantageous.

I hope this helps.

Corey

* NOTE: Some original wording has been modified for legibility.

End of Day Post

The markets closed higher for a second day in a row, putting an end to the current surge of selling. GDP for the second quarter was revised slightly higher than expected, and the weekly jobless claims report decreased from last week. Both of these reports are indicating that the U.S. economy is still showing signs of strength and could have contributed to today's rally.

Today's close did confirm a new pivot low in the markets. This doesn't mean it will hold or we will necessarily continue higher, but a bounce here can trigger new opportunities in both directions.

The VIX is still in dangerous territory, so we should continue to stay cautious. Technically, the last two days should be viewed as an oversold bounce and/or the start of a bear rally pattern. Overall, our longer-term outlook should stay to the bear side. We are anxious to see how Friday plays out and what pattern the market gives us going into the weekend.

Continue to wait for confirmation before entering new trades. We just established a pivot low in the markets, so there is no reason to try and guess how far this bounce will take us.

Mid-Week Outlook

• Bullish: 14%
• Sideways: 48%
• Bearish: 38%

Have a great night,

The Maverick Trading Team

SLB: Highlighted Trade From One Of Our Traders

Another great trade made in Schlumberger (SLB), a basic materials company specific to oil and gas equipment and services. This trade is a nice example of using increasing volume to extend a possible target ‐ in this case, to the downside.

There are many different trading strategies available to take advantage of this type of setup in the options world. In this case, our trader wanted to take advantage of favorable volume. The trader decided to use a diagonal put spread, with the ability to adjust and take advantage of further gains.

Typically, for the strategy chosen, the risk is the premium paid and our traders aim for a 50%+ return. At Maverick Trading, we pride ourselves on our community of traders. Every week in our live Trading Room, our traders share their favorite new trade setups (like the one above from last week) with all of their fellow Maverick traders.

NOTE: Chart(s) courtesy of FINVIZ.com.

End Of Day Post

The markets appeared to be making an oversold bounce today; however, another round of selling sent them even lower into the close. The INDU made a 600 point swing today – up over 400 points earlier in the day and then closed down 205 points to end the day.

Today's action is the continuation of the same move that started last Friday, as the markets continue to search for support. The market action today is a testament to why we need to see the formation of a pivot point before taking action in directional trading. This amount of volatility can be dangerous and unpredictable and guessing here will just cost you money...no reason to try and catch a falling knife.

We have seen some overseas weakness, specifically out of China. However, there really isn't much in the headlines to warrant this type of market reaction. That being said, there is an enormous amount of fear driving this current move and we should continue to expect high volatility.

If you are going to take new trades here, then ensure that they can survive this volatility. Consider lower position sizes and increasing trading ranges for better probability. Options could be a little more expensive here and have wider than average bid/ask spreads. Make sure to take this into consideration when entering or adjusting positions.

Have a great night,

The Maverick Trading Team

Managing Collar Trades Before/At Expiration

From Our May 2015 E-mail Archives: One of our traders had a question about Collar trades before/at expiration, so he asked our Head Trader, Robb, for some guidance.*

-----Original Message-----

From: Evan S.
Subject: Collar Trade Management

Robb,

I just watched the "Retirement Planning – Session #3" class that you did on April 28, 2015. I had a quick question on trade management for the Collar trades; specifically, what needs to be done before/at expiration? The risk graph looks like a vertical spread, but as I'm thinking through it, the trade management will not be the same. In thinking through it, I believe that you should do the following if:

1. Above Max Gain - Do nothing, short call will be exercised and you receive full premium, long put expires worthless and you will sell the stock


2. Below Max Loss - Receive the full premium on the short call and it expires, long put will be exercised and stock will be sold


3. Between Max Gain And Loss - Do nothing, receive full premium on short call and it expires, long put expires worthless and you keep the stock

Is this correct? Basically, you never have to do anything...it is just a matter of "Do you sell the stock or not?", right?

Thanks,

Evan S.


-----Reply Message-----

Hi Evan,

You have the right outcomes if you just let everything get exercised. However, there are actually some things that you can do to hold onto your underlying ETF/position. Here are the choices that you have on each:

1. Above The Call That You Sold
1. Do Nothing – You were correct about the outcome
2. Buy Back The Call That You Sold – You may end up taking a loss on closing this short Call (if you are paying more to close the Call than you originally collected). However, you should have a nice profit overall. This is due to the stock having increased much more than the loss in the short Call position. By buying back the Call, you have removed the cap on the upside and are now back to a simple long stock position (with a profit). You would either let the long Put just expire worthless or close it out if there is any value left.
3. Roll Up To A Higher Strike – Let’s say that you own an ETF and sell the $35 Call for $1.00 when the ETF is at $34. The ETF moves higher (unexpectedly, since you placed a Collar) towards $35.75 and looks to be breaking out. You could buy back the $35 Call for probably close to where you sold it and you could sell the $36 Call for $0.75 (or whatever the market price was). You have now given your underlying an extra $1 of profit. You would either let the long Put just expire worthless or close it out if there is any value left.


2. Between Max Gain and Loss
   1. You are correct in your analysis and there really aren’t other choices.
   
   
3. Below The Put That You Bought
1. Do Nothing – You were correct on your analysis
2. Sell The Put For A Profit And Hold The ETF – Obviously, this is the correct choice if the stock/ETF has reached a bottom and bounces higher from there. You will simply sell the Put for a nice gain, which offsets the loss on the ETF. I just did this in my retirement account two weeks ago on a long Direxion Daily Russia Bull 3X ETF (RUSL) position when it hit $36. I bought Protective Puts and closed out the Puts when the ETF pulled back to $31. I still hold the position.

Hope this helps,

Robb

* NOTE: Some original wording has been modified for legibility.

End Of Day Post

The market's broke down today as support finally gave way. All three indices broke major support levels, giving up more than 2% on the session. Yesterday’s FOMC statement didn’t give too much clarity on whether or not a rate hike will happen in early September. Today’s move was more of a technical one, rather than a reaction to a news event or economic catalyst.

Today’s action included large volume, big range and a huge spike in volatility. The cause for this move isn’t as important as its effect. The amount of selling through these levels indicates a huge swing to bearish sentiment. With all of today’s action, along with the VIX spiking above 19, we should expect more weakness moving into next week. Don’t be surprised if we get an oversold bounce tomorrow, but unless we retrace back above support levels, it’s nothing more than just that.

August expiration is tomorrow, so make sure to address your portfolios. You may want to double check those bears. Usually, we would suggest taking your time in building positions going into next month; however, today has opened up some bearish opportunities. Make your trades as they confirm, but stay mindful of your overall account exposure.

Mid-Week Outlook

• Bullish: 8%
• Sideways: 32%
• Bearish: 60%

Have a great night,

The Maverick Trading Team

AET: Highlighted Trade From One Of Our Traders

Here is a great trade made in Aetna (AET), a healthcare benefits company. This trade is a good example of implementing a gap strategy, along with using it as a possible target.

There are many different trading strategies available to take advantage of this type of setup in the options world. In this case, our trader wanted to take advantage of a recent gap. The trader decided to use a vertical spread, using the gaps range to select strike prices for the combo.

Typically, for the strategy chosen, the risk is the premium paid and our traders aim for a 50%+ return. At Maverick Trading, we pride ourselves on our community of traders. Every week in our live Trading Room, our traders share their favorite new trade setups (like the one above from last week) with all of their fellow Maverick traders.

NOTE: Chart(s) courtesy of FINVIZ.com.