WAITING FOR VIX and VXO

The market just wants to go down it seems. Even a coordinated injection of over US$200billion has failed to calm nerves. Good CPI number? Yup, only to be torpedoed by the news of a bailout of Bear Sterns (by JP Morgan and the Fed, of all people). The VIX also closed at 31.16 which is the highest VIX close since March 2003. It's obvious that we're going into what will be a
volatile and roller coaster Options Expiration week. In addition, Put/Call ratio (CBOE) is at 1.16, the highest since, you guessed it, March 2004. So March seems to be a month of extremes! (and we thought it was October). It becomes clear that fortune favours the brave in March.

Looking at our "Triangle of Hell", the SPY is increasingly underpressure to test its support of 127.5 and its low of 125. If this breaks, we should see 122-122.5 and if that breaks....err, I don't want to talk about it since we'll have to seet the monthly fib retracements to get an idea of where we're going to (hell, that is).


It's possible that we have some ways down to go, which could result in"a bottom" (don't ask me whether it's "the bottom"). There are several reasons for this (aside from VIX and Put/Call extremes):
1. The market looks like it's extremely oversold (which is not a reason to buy the market anyway, since oversold leads to more selling) with pessimistic extremes. Notice how market turns happens when chicken little cries that it's the end of the world (for Bear Sterns investors, it probably is)
2. The Yen, which is a barometer for risk, is showing extremes with commercial traders at 0 (short yen) and specs at 100 (long yen). The recently released CFTC data shows specs reducing their long yen and long euro positions. This could be the recipe for a blowoff top (or bottom). I am encouraged by the Yen's movement which hit our 261.8% fib target at 99.15 which means a recovery rally is expected.
3. Historically, this could be "March madness" - when such extremes last happened in March 03 and March 04, the markets popped up.
4. Central Banks are in an intervention mode nowadays as can be seen from last week. The Bank of Japan could spring into action and stem the rise of the Yen, saving its manufacturers.

So how do we take advantage of this situation? First off, we shouldn't panic ourselves. Once we get this pyschological thing, then we have to lay the trap door for the frightening apex of VIX which could occur soon. In this case, we are waiting for extreme panic in the market, with VIX spiking to at least 37, with breach above 40 highly probable (in the late 1990s and early 2000s, the VIX spikes were at 45-50). Once capitulation occurs and is supported by VXO moving inside the Bollinger band, we have several choices:
1. SHORT the reverse proshares of the Dow (DXD), S&P500 (SDS). You get more bang for the buck as it moves twice as fast as the Indices themselves, i.e. DIA and SPY
2. BUY the ITM Options on the DIA to catch the fast and furious capitulation rally
3. BUY stocks which have held well during this rally, for example, those in the commodities complex, particularly agriculture and gold
4. Do a COT trade on the USDJPY (or AUDJPY) in 100 pip decrements. Note that your account must be able to sustain drawdowns. As the shorts clear their positions, the run-up will be fast and furious
5. Buy ITM April call options and increase your position as the USDJPY goes down
by 100pips. You can do this with Exchange Traded Options on ThinkOrSwim or with
Vanilla Options on Saxobank (you can even consider a similar strategy using OPTIONS on the USDCHF pair)
6. Once capitulation occurs, lock in the value of GBPJPY for one month. Buy the currency pair and sell a call option to give you around 1200-1500 pip protection. You should cruise earning the interest differentials in the next month, which works out to US$2.60-US$3.00 per mini lot a day. Why bother trading when you can earn interest,by allocating US$1,500 per mini lot? Scared of the volatility of GBPJPY? Then try out AUDUSD and buy yourself a 350 pip hedge.

These strategies should take into consideration your expertise. Pick something which you are most comfortable with.

The chart below shows how the markets behaved on the previous VXO and VIX peaks. The
markets turned promptly, rewarding strategic and patient investors many times over.
I rest my case.....Good luck and BOOYAH!


Note: These guidelines can be implemented by students who attend my FXOPTIONS classes. Don't try doing what you don't know, especially for new traders. Learn first lah!

Chief Shook