Volatility — and the fear and uncertainty that go along with volatility — are a lead weight around investors and income seekers trading legs. How do you invest in a high-yield stock when a Greek bus driver’s strike could get out of hand and reduce the value of that stock 5% in a nanosecond? Or the trading robots run by hedge funds lose their mind again and a flash crash hits your high-yield portfolio?
Simple: Trade volatility. As I said, turn that lead weight into gold in the form of weekly income. Sell weekly puts against the S&P 500 VIX Short-Term ETN (VXX), the exchange-traded fund for the VIX, the measure of market volatility.
How it can work for you
You enjoy several critical advantages when using this position as part of your income strategy:
- The VXX is a traditional put easily rolled into another week if the underlying ETF temporarily moves the wrong way.
- Premiums on the weekly puts are always higher than on most names, and as volatility increases in the market, these premiums often rise much faster than volatility itself. It is not uncommon to see premiums that would generate income equivalent to one-half to three-quarters of one percent return on capital from puts that expire in two or three days and are as much as 10% out of the money.
- If you are put the VXX you can easily turn around on Monday morning and sells calls with equally high premiums.
- Volatility never goes away — the VXX does not represent a company that can go bankrupt. If you are put the VXX you know that one-day volatility will rise unless you are in the middle of a market crash.
As we are not in the middle of a market crash, selling weekly puts on the VXX is a great income tactic right now. As I write this, the VXX is selling for $19.50 and the $18 put is selling for around 20 cents or $20 a contract. That is a potential return of more than 1% in three and a half days. Even the $17 put has a decent return — it sells for around a dime or $10 a contract, a return of more than one-half of one percent in a week.
Do this 50 times a year and you have annualized returns of 25% and 55% a year.
You also have a nice hedge against market uncertainty and a riddle for your next dinner party: How can someone turn lead into gold?