ETF Expert

What index has a better 1-year track record than oil, gold, your favorite emerging market… even China? Answer: The CBOE Volatility Index (VIX).

The CBOE Volatility Index (VIX) garnered 130% over the last year. Aggressive investors have long clamored for an ETF investment that tracks volatility. So far… there have been no suitors.

Even though we do not have an ETF that tracks volatility directly, we can learn quite a bit from the CBOE Volatility Index (VIX). For a quick primer, you may wish to review, "Volatility Is Back: Who’s Gonna Be In Trouble."

At the time of my earlier post, I made the case that traders could profit from UltraShort Consumer Services ProShares (SCC) if the VIX Index climbed steadily. Indeed, the VIX tested its lows around October 9, just as the stock markets had reached new highs. And then, the VIX Index move steadily higher, reaching a 52-week closing peak of its own in mid-November.

Not surprisingly, then, as volatility climbed from 16 to 31, the stock market suffered. And few areas of the market suffered as miserably as the consumer discretionary arena.

Hypothetically speaking, let’s say that an aggressive investor used the CBOE Volatility Index (VIX) support level of 16 as an attractive entry point to use a short fund. Between early October and mid-November, UltraShort Consumer Services ProShares (SCC) investors may have seen 27%+ gains in an aggressive trade.

However, here’s the problem. After the VIX topped 30, if the aggressive investor did not take the gains and move on, he would have been hit hard by this late November run; that is, the 2-day stock market surge replaces a potential 27% profit with a 17% gain.

(Today the VIX fell to 24 as the U.S. stock market spent 2 days moving straight up.)

The point here is not to discourage traders from enjoying 17% appreciation. The point is to show investors the quickness with which short funds may get wiped out.

Minding the CBOE Volatility Index (VIX) is critical for traders and investors alike. Greater volatility with a VIX that is climbing means that the stock market is super skittish. (And it usually means that fear/panic will cause selling pressure.)

In contrast, lower volatility with a VIX that is falling means that there’s greater certainty. And that tends to favor stock assets.

Moreover, high points like 31, often mean the end of fear; low points, like 15, may indicate complacency.

Right now, the CBOE Volatility Index (VIX) appears to be trending lower… and that should help stocks in the near-term. Yet the elevated level on the VIX of 25 could also be telling us to expect erratic price swings for a while.

How do you invest in that environment. You stay diversified across uncorrelated assets! I mentioned a variety of ideas in my morning review.

For instance, consider a combo of the S&P 100 (OEF), Vanguard All World excluding US (VEU) and Global Consumer Staples (KXI) for stock assets. Look to commodities with the iPath Dow Jones-AIG Commodity Index (DJP) as well as currencies like the CurrencyShares Swiss Franc Trust (FXF). Also, remember your international bond choices, such as the SPDR Lehman Intl Treasury Bond ETF (BWX) or the PowerShares Emerging Mkts Sovereign Debt (PCY).

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.