Market Playground

By Robert Zingale

The European debt problems appear to be resolving, and economic data from the U.S. has recently been strong as well. My portfolio strategy may change for the month of December, since the VIX futures have recently reentered a state of contango.  If contango persists, then I will replace my short VXZ (iPath S&P 500 VIX Mid-Term Futures ETN, NYSEARCA:VXZ) exposure with a short exposure to VXX to profit from the term structure.

To protect against any possible spikes in VIX, I am choosing to primarily short VXZ instead of VXX (iPath S&P 500 VIX Short-Term Futures ETN, NYSEARCA:VXX) right now, because VXZ increases less than VXX when VIX quickly spikes. This will hopefully provide some protection against moments of hysteria in the market, while also profiting during VIX declines. I will switch my strategy’s allocation to shorting VXX instead of VXZ if there is a long-term sustained decline in the VIX index coupled with a state of contango.

VIX Index Forecast

Based on the VIX futures term structure and current market conditions, I expect VIX to trade between 20-45 in December. This is the largest range that I’ve ever expected going into a month because I could just as easily see VIX continuing to trend downward as well as additional European debt worries rise up again.

VXX Forecast 

I also expect that VXX will primarily respond to changes in the VIX, which could result in a large trading range.  Therefore, VXX has a strong chance of being sharply higher or lower in December.

Current Position Rationale 

I am currently (as of 12/2) short VXZ to protect against VIX spikes while positioned to profit in the event of VIX declines. I may go short or long short-term volatility through VXX or XIV (VelocityShares Daily Inverse VIX Short Term ETN, NYSEARCA:XIV) depending on shape of the VIX futures term structure. If shorting short-term volatility, I would then exit my VXZ position. If going long short-term volatility, this would be in complement to being short VXZ.

The above article comes from Covestor. For more information on Robert Zingale and to view his Volatility Mean Reversion Covestor Model, visit Covestor.com.

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