To say that the start of 2016 has been a rollercoaster for investors is a gross understatement. Depending on your investment strategy 2016 has been a difficult year to navigate through. The market has been filled with turbulence and uncertainty where the smallest news sends the markets into a tailspin, neglecting fundamentals. In a volatile environment, such as this, it’s hard to devise a profitable investment strategy due to markets emotional veering. However, there are opportunities to turn the enemy, the market volatility, into your friend and profit from it.
We will discuss three strategies you can utilize to take advantage of market volatility, these range in complexity and are ordered in ascending order of risk.
Buy on Dips
One lesson history has taught us is that no matter how bad things get in the short-term, in the long-term the market trends upwards. That means that you should add to your portfolio on days when you see big drops in stocks, assuming there isn’t a fundamental justification for the drop and you have a long-term goal. As the Oracle of Omaha, Warrant Buffet, put it “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
Options strategies are great when you want to limit your losses and have exposure to unlimited profits. Options strategies can be designed to take advantage of volatile markets. When you know there will be significant price movements, but not sure which way it will go you can implement simple options strategy to profit from this price changes. A simple strategy is the Long Strangle: you buy an equal number of at the money call and put options with the same expiration date, as long as the stock, or underlier, moves enough you will make a profit, the direction doesn’t matter. Your loss is limited to the cost of the options while your upside is unlimited, theoretically. You can reduce the cost by buying out of money options, which will require a more significant move in the underlier, or you can buy options with shorter expiry in which case your underlier needs to move sufficiently by the time expiry date.
Invest Directly in Volatility – VIX®
CBOE’s VIX® index measures market volatility. A VIX® value of under 20 indicates calm markets while a VIX® value over 30 is associated with high level of uncertainty and volatility. During the recent market volatility we have seen the VIX® close as high as 41.74 in August 2015, although intraday VIX was over 50 on the same day. Since VIX® is a measure of volatility it would make sense to invest in it directly; unfortunately, investing in VIX® directly is not an option currently. The good news is that you can purchase options and futures as well as ETFs and ETNs that track VIX® futures. There are also leveraged ETFs that offer more risk and more reward for the brave heart. Be advised that since these are derivative products, or based on derivatives, they do not perfectly track VIX and lag. These should only be considered as short-term strategies.
Volatility is seen as a negative occurrence and is associated with bear markets, but a shrewd investor can advantage of volatility.
**The above are simply suggestions and not actual trade guidelines or recommendations.