As markets quiet down, on trader thinks its high time to buy cheap protection for one’s portfolio.
“We’re coming into the end of the year here, and complacency is high,” as stocks have rallied to all-time highs since the U.S. election, Todd Gordon, founder of TradingAnalysis.com, said on CNBC’s “Trading Nation.”
That makes it is prime time to buy “cheap insurance” against some of his long positions heading into next year.
It’s complicated, but Gordon is making it simple: He’s betting on pre-inauguration volatility by buying the short-term futures volatility ETF (VXX).
The VXX is an ETF that is designed to track the CBOE Volatility Index, which itself uses the prices of S&P 500 options to track traders’ expectations of future market moves (and in doing so, essentially serves as a market fear index).
Since the VXX tracks VIX futures rather than the index itself, the ETF doesn’t move perfectly alongside the index, and tends to seriously underperform the VIX over longer time periods.
To make his trade, Gordon turns to VXX options — which can be thought of as a derivative (options) of a derivative (the VXX) of a derivative (VIX futures) of a derivative (the VIX) of a derivative (S&P 500 options) of an index (the S&P 500).
Specifically, he is buying the January 25-strike calls and selling January 27-strike calls for 47 cents per share, or $47 per options spread.
For Gordon to break even on this trade, the VXX would have to close at or above $25.47 on Jan. 20, which happens to be Inauguration Day. If the VXX closes below $25 on that date, Gordon’s trade would lose the $47 he spent. But if the ETF heads higher and closes at or above the $27 level, the trade would be worth $2, for a profit of about 300 percent.
Of course, if the VXX does rise to that level, it will likely mean that his long stock positions have lost money — making this a hedge, rather than an outright bet on the ETF.
Trader takeaway: In order to pick up cheap portfolio insurance, Gordon is buying the January 25/27-strike call spread on the VXX ETF.