Is $VXX a channel-trading paradise?

• Posted by chicagosean
• on July 23rd, 2010

I position my portfolio to benefit from rising volatility. It is my thesis that the investing landscape over the foreseeable future will see sustained high levels of volatility, interrupted by brief and fleeting mini-panics before this now decade-long bear market runs its course.

Currently, I express my long volatility/bearish opinion by being long $SPY puts. This is a fluid position that is added to during periods of shrinking volatility, and lightened during periods of rising volatility.

In recent weeks, I’ve begun to pay attention to $VXX (iPath S&P 500 VIX short term futures ETF). It is a very liquid market trading north of 20 million shares a day regularly that tracks changes in volatility.

I have a trader friend who claims to be “killing it” with this product lately and he certainly has my attention. If there are easier ways to express my market opinion, I’m always interested in taking a look.

A quick view of recent market action suggests $VXX quite possibly could be a channel-traders’ dream:

Simple, right? $VXX is a buy anywhere below $25 and a sell anywhere above $30. Rinse. Repeat. Go on vacation.

However, when you look at the weekly chart of $VXX since its inception in early 2009, the picture changes dramatically:

From this view, $VXX looks like its on a painful slog to oblivion. Is it possible this product could trade to zero? I honestly don’t have an answer to that question. I’d like to think NO. But I’ve seen weirder things happen.

If the answer is in fact NO, and if $VXX has established $18.00 to be about as low as it will go, then there would seem to be an excellent opportunity to trade this product from the long side and buy when its “low” and sell when its “high” over and over again. Because as we know, volatility rises and falls (sometimes quite spectacularly) on a pretty consistent basis.

However, a point of concern is what appears to be a consolidating range as viewed in the daily chart I listed above first. As $VXX “finds its level” we may not see the channel as wide as its been. Instead of oscillating between 25-30 (a 20% gain from 25-30), it may settle into a 22-25 range (a 13% gain from 22-25).

I’m just throwing an idea out there to see if anyone else has any thoughts on this? Anybody trading this product with a similar idea that can add some perspective here?

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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