Random Walk Trading – Professional Live Webinar VIX
VIX based trading — making profits on the “Fear Index”
Markets have always allowed us to bet on fear or greed. Now we can bet on volatility too…
The “random walk” of the market, is just another way to say “noisy” walk. Daily increase and decrease of prices usually trace out a path that is very similar to the volume of the hiss that you get from a radio tuned to a channel with no stations. One difference is that markets also have “drift” — they tend to go up or down at a longer time scales based on macro economics, wars, fear & greed, and who knows what else. For reasons that are not clear to me, the magnitude of the “noise” on a market tends to be proportional to the square root of the time span. For example if the magnitude of the annual noise is 12%, the daily noise will tend to be around 12% divided by the square root of the number of trading days in the year — about 250. The square root of 250 is about 15.8, so the daily change in this example would be 12%/15.8 or around %0.76 The minute to minute variations are predicted to be 12%/346 (square root of 250*8*6) = ~ .035%. On the Spy S&P 500 index this would be around 4 to 5 cents. Eyeballing the charts for daily and by minute high vs. low these predictions look pretty close.
So is there a way to take advantage of this level of predicted noise, without having to guess which way the market will “drift”? I think not, because if people had figured this out they would be writing books about it while sitting on their decks in Maui.
The big challenge is to avoid getting caught if the market drifts in a direction contrary to your position. Let’s say you buy SPY at opening at $130 with a sell order set at $130.99 (0.76% higher). The theory would predict that you would succeed with this strategy about 50% of the time on the 1st day. If the market is “going sideways” with no clear overall trend or trending up, the odds are very good that you would close out your order successfully within a few days. However, if the market decides to tank at that point you may have to wait a very long time for your sell order to execute. So is there a cost effective way to collect the likely day-to-day gains but not get wiped out if the market tanks? One approach would be to buy puts at the current support level of the trading range. If the market tanks you have at least limited the potential damage. Your loss would be the difference between your buy-in price and the put strike price and the put option premium. Another approach would be to hedge with $VIX volatility options which tend to go up when the market goes down. These have the advantage that they are profitable if the market drops suddenly, regardless of what prices the SPY index is selling for.