Here’s How To Trade The New VIX — Part 1

They Actually Threw A Mother Out Of The

Well, the Little League Baseball and Fast Pitch Softball
Season has now officially begun here in Southern California with both my kids
playing their opening games last weekend. This is the first time in a while that
I have not been a manager, coach, assistant coach or water boy for one of my
kids’ teams. At first I felt very guilty about this but that guilt has passed
(and you’ll soon see why). I help out from time to time when asked and the fact that I’m not
getting phone calls seven nights a week from parents really is an enjoyable

So you can imagine how much I was looking forward to my
son’s opening game last Sunday, knowing I had no responsibilities. He and I
arrived at the field at 8 am for his team’s warm-up, I took out my fold-up
chair, placed it in right in front of the ball field, and opened my New York
to enjoy the warm Spring morning sun that makes Southern California
one of the nicest places in the country to be in March. And this nice peaceful
experience lasted a good 3-4 minutes before one of the coaches ran up to
me and asked, “Can you help coach today? One of the guys can’t make it.”

Being the nice guy that I am (OK, SAP) I mumbled, “Sure,
I’d love to.” So I folded up my chair, put my newspaper away, got my glove from
my car and proceeded to again be “Coach” (they even gave me a shirt that said
“Coach” on it). And of course, being low man on the
totem pole meant I got the job that no one else wanted…being bench coach for
13 hyperactive bat-wielding 6- to 8-year-old kids who can’t sit still for a nanosecond.

My concerns about the kids killing each other with (and
without) the bats was unfounded, though. They played well, behaved well and none
needed to be rushed to the local emergency room. And, I wish I could say the
parents behaved as well as the kids…but I can’t. The kids are truly
clueless as to what the score is and who’s winning (I heard them quoting scores
ranging from 0-0, to 20-19, to 346-184. And of course according to the kids, we
were winning with each of these scores, which we weren’t. We were losing every
inning for the entire game). But as I said, the kids don’t know any of this, nor
do they seem to care. But for the coaches and parents…that’s another story.
For them, the home opener seemed to be a matter of life and death.

First, there were at least three times during the game
that I thought a fight may break out amongst the coaches (and the league we play
is made up of educated, upper-middle-class citizens and at least the coaches on
my son’s team are really good guys). The third of the three near-battles
involved a play my son was in. Runners on first and second, one out. He’s at
shortstop and a hard ground ball is hit to him. He fields the ball, pivots to
make the force at third and as he’s about to release the ball he notices our third
baseman is not at the base. In fact, our third baseman hasn’t even moved since
the ball was hit. Why? Because at that moment, a hang glider was sailing
over the field and the kid was in a trance-like state, staring at this guy as he was
through the sky.

My son, seeing this, decides to race to third where he
beats the runner out by a step. Nice play right? Coaches and parents on both
teams should be commending such a heads up play by a kid, especially one who
hasn’t even graduated kindergarten yet. Wouldn’t you think so? Well not from the
other team’s coach (and his assistants). They come running out onto the field
screaming “INTERFERENCE! He interfered with our runner!” Our runner should be
safe…and on and on and on. And this is being done right in front of our
dugout, which promptly brings me onto the field. And as the coaches are arguing
about the play (and acting as if the umpire doesn’t exist), I’m reminding the
coaches on the other team to “Forget about it, he’s 5 years old…let it go,”
(plus the play wasn’t even close to interference). Thankfully, the 13
bat-wielding 6- to 8-year-olds on the other team didn’t come after
us (they also were too busy watching the hang glider) and no punches were thrown. Runner out!

So my intentions of sitting back and enjoying a quiet
morning of baseball eventually turned into a day that had as much mayhem as a
World Wrestling event. But what topped the game off was what happened to the
only mother assistant coach in the entire league. She had the honor of being the
first coach this season to be ejected from a game. That’s right, the kids are
ages 6-8 and the mother was tossed out. The umpire had had enough of her. He
made her watch the rest of the game from the stands (and worst of all she had to
deal with the evil glares of the 13 moms of the kids on our team…a fate no one
should have to endure!).

I love it! Another season of Little League baseball is off
and running!!!

A New Market To Trade

As many of you know, next Friday (March 26) the
CBOE will be launching a futures contract to trade the Volatility Index (the VIX).
This instrument may end up becoming one of the more popular trading vehicles
available as its potential use is widespread, especially amongst fund managers.
For nearly a decade I have been researching and publishing information on how to
use the VIX to help better time stock market entries.

Now, for the first time, we’ll be able to use this
research to trade the outright instrument and in our opinion there may be
tremendous opportunity here.

Over the next few weeks, I’ll share with you some of our
research on trading the contract. This week, to make sure we’re all on the same
level playing field, I’m going to do an introduction as to what the VIX is, what
it means and how it can be used. For many of you this will be new and for others
this will be a review. And then next week we’ll start building on this base and
begin looking at the opportunities that exist.


What is the VIX? The VIX is the market estimate of future
volatility, based upon the weighted average of the implied volatilities of a
wide range of strike prices for S&P 500 options traded on the CBOE. This
definition may be difficult to understand but it should become clearer as we
proceed. What’s important to understand is that when volatility increases (and
this usually happens when the market declines as has happened recently) the VIX
rises in value. When volatility decreases (and this usually happens when markets
are rising or are quiet as the market has been before the past few weeks), the
VIX decreases.

Using The VIX

Why does the VIX rise when markets decline? Because
declines are usually accompanied by fear (again, think about the past few weeks
with the terrorism fear). The more fear that’s in the marketplace, the more
aggressive hedgers and speculators will be in buying put options to either hedge
their long positions or to profit from an expected further decline.

When the fear passes (think this past Tuesday and
Wednesday) the market rallies and the demand for puts collapses as does the
value of the VIX.

Here is a recent chart of the VIX. As you can see, when the
market was quiet in February, the VIX was low. It then spiked up to its highest
level this past week before declining, as fear left the marketplace and stock
prices rose.

One of the edges that exists for traders is the times when
the VIX is stretched too far away from its 10-period moving average. When it
closes 10% above its 10-period moving average, it’s historically preceded strong
short-term rallies. When it’s been well below its 10-period moving average, the
market has proceeded to move sideways to down over the short term. The bigger
the stretch from the moving average, the nearer the move will likely be and the
bigger the potential move will be. On Thursday, March 11, the VIX closed 30% above
its 10-period moving average (something that is very, very rare when the S&P 500
has been above its 200-day moving average). The next day the Dow rose 111
points. On Monday March 15, the VIX closed 24.7% above its 10-day moving average
(again, a level rarely seen in an upward-trending market). The next two days the
Dow rose 197 points.

This pattern of the VIX stretching away from its moving
average and then seeing the market rally has occurred over and over again since
the VIX was first calculated in 1986. It’s far from perfect but it has done a
very good job of predicting future stock market moves.

The New VIX Futures Contract

On Friday, traders will have the opportunity to trade the
VIX outright. Based upon our initial research, we feel there may be more
opportunity to use analysis such as the analysis mentioned above, with the VIX
itself versus using it to trade the direction of the stock market. Next weekend,
after the contract has opened, I’ll share with you some of the research we have
and some of the ways you can use the new contract for your trading.

Have a great week trading (and look out for that irate mother
who was thrown out of my son’s Little League game)!

Larry Connors