If you have ever watched financial media or read financial news, you undoubtedly have heard of the volatility index NYSEARCA:UVXY.
While NYSEARCA:UVXY is a very popular product, many people have absolutely no clue where it comes from or exactly how to trade it. We have to warn you, trading UVXY is no walk in the park and has caused many investors to completely blow up their accounts.
Being on the wrong side of volatility can be the difference between making money or losing money over the course of a year. UVXY is a tool that can put the odds on our side (if we understand what we are doing).
I’d like to walk you all through what UVXY is and exactly how we like to trade it so that we can give ourselves the best chance to make money. Here we go, Stony Brook Securities ultimate guide to trading NYSEARCA:UVXY.
What To Do With ProShares Ultra VIX Short Term Futures…
Before we can move forward and see what types of trades we can do here, we have, to begin with, what we begin with every time. We have to check and see if the product is liquid enough for us.
Why do we keep on doing this? Because we want to hammer it home that liquidity is the single most important filter before deciding the trade or invest in any product.
If we find something that is not liquid, we must walk away as in order to trade illiquid products we have to continue to give up money to enter positions. As a buyer, we will have to buy above midprice and as a seller, we will have to sell below mid price.
When we do this, we have to take an initial loss on any position just to execute it. This is not worth our time or money as there are hundreds of liquid options available to us every day.
Is nysearca:uvxy Liquid Enough?
In order to find out if a product is liquid enough, we must find out if it’s stock and options are both liquid enough. We must make sure that both are liquid as we cannot give ourselves the best chance to make money without them. If the stock is liquid but the options are not, we move on.
When checking stock liquidity, we look to see the following:
- Bid/ask spread a few pennies wide
- Volume in the millions
Since UVXY is so popular these days, we expect to be impressed by its stock liquidity.
We expect to see a small bid/ask spread.
And that is exactly what we get. One penny wide. It does not get better than this.
We also expect to see volume in the millions.
And we do. In a BIG way. In fact, the total notional value of stock traded today was almost three-quarters of a billion dollars or $713,310,711.13. This much volume and notional value is a clear sign that there are a lot of institutions and money managers trading in and out of this product all day.
The stock liquidity is very high here and we are hoping options liquidity for NYSEARCA:UVXY is equally as impressive. Here are the four factors we look for in determining options liquidity:
- Volume in the thousands
- Monthly and weekly expiration cycles
- Bid/ask spreads no more that a few pennies wide
- Open interest count in the thousands
We are very hopefully that NYSEARCA:UVXY will have similar option liquidity as its stock.
We hope to see volume in the thousands.
Even better; we see hundreds of thousands of contracts traded.
We hope to see monthly and weekly options. We will get weekly options if there is enough demand for them. Remember, demand bring liquidity.
We sure do. We see expiration cycles which occur every single Friday.
We hope to see bid/ask spreads no more than a few pennies wide.
We see at most, the bid/ask spread is $0.03 wide during trading hours for the out of the money options. It rarely gets better than this!
We finally expect to see open interest in the thousands. If open interest is in the thousands we have confidence that there is a lot of money tied up in this product. If there is a lot of money tied up in this product, it means there are institutions involved. We always want to follow the money because those institutions (like us) refuse to trade in inefficient products and markets.
We see strong open interest numbers pretty much across the board. In fact, every one of our checkpoints for options liquidity for NYSEARCA:UVXY passes with flying colors.
UVXY’s stock showed efficient markets with a ton of volume.
UVXY’s options also showed efficient markets with a ton of volume.
We can say with very high confidence this is a product that we can go ahead and look for trades or investments in as we will be able to execute an order at fair market value.
What Can We Do Here?
Let’s get right into it. Before we can tell you exactly how we trade this product, we have to first talk about what it is in the first place.
UVXY is a stock that can be bought or sold like every other stock out there through an online brokerage account. While there are a lot of similarities between UVXY and other stocks, there are a few differences.
First, UVXY is not a company or corporation. There are no sales, earnings, profits, losses, price to earnings ratios, or dividends. For these reasons, investors cannot do any fundamental research as there is no balance sheet or forwards earnings to this name.
With so many differences to most other stock out there, how has this stock done?
Remember, the goal of UVXY is to give us a leveraged return of volatility or the VIX.
Here is what this stock has done over the least three years.
Not pretty to say the least. We can see this chart is going the wrong way for those who hope to get long the stock. This much is obvious. But how does something like this happen? Doesn’t volatility (VIX) look like this?
Compared to UVXY, the VIX looks like it does not continue down and to the right and finds some floor around the $10 area. Here are the two products together.
But if UVXY is just supposed to be triple the movement of the VIX…what is going on here? Shouldn’t it just have higher and lower swings than VIX?
We can see while UVXY and VIX are highly correlated (over 70), they are not as correlated as one would imagine. Since UVXY is one of the volatility indexes investors know about, we would expect the correlation to be much greater.
How Does ProShares Price NYSEARCA:UVXY?
Since there are no earnings or corporate events or balance sheets, how does ProShares maintain a price for this product?
Since there is no physical product or service for UVXY to be priced from, ProShares finds the price by holding a basket of the front two-month futures contracts.
Here is an example of the first two months of Vix futures contracts. We see /VXJ7 trading for $13.55 a contract and /VX17J7 trading for $13/75 a contract.
Let’s say that ProShares sets the price of NYSEARCA:UVXY by always maintaining 50 futures contracts at all times.
Today, they have 25 contracts of each. A week from now, let’s assume the price of both contracts remains the same. Each contract gets seven days closer to expiring.
/VXJ7 will then expire in sixteen days and /VX17J7 in 23. As /VXJ7 continues to get closer to expiring, ProShares must start to move contracts out of that front month and into the back month because they always need to maintain that count of 50 Vix futures contracts. We call this rolling. Once these contracts expire, they no longer are tradable thus if there were any expiring contracts in that bundle of UVXY, they would be worthless.
In the scenario painted above, ProShares must sell /VXJ7 because they are long 25 contracts, while at the same time buy more /VX17J7 (further away from expiring) contracts. Remember, they have to keep the ship failing and in this case, always maintain 50 contracts.
If they were to sell a /VXJ7 contract for $13.55 ($13550) and buy one /VX17J7 contract for $13.75 ($13750), they would effectively be maintaining the price of NYSEARCA:UVXY by taking a loss. In fact, they would be maintaining the stock by taking a $0.20 or $200 per contract loss.
The scenario we spoke about above where the price of the futures contract further away from expiring is higher than the price of the futures contract closer to expiring is known as contango.
Contango is perfectly normal and unfortunately for those who were considering getting long UVXY, is a phenomenon that occurs 80% of the time.
What you just read it real. 80% of the time, the basket of futures that set the fair market value price for this short term Vix product cause ProShares to take a loss. And when ProShares takes a loss to maintain the product, what happens to the price of the product?
It has a negative drag.
So we show this chart again. Vix in the green/red and UVXY in the pink. In order to maintain the price of the product, ProShares must take a loss rolling the futures out to a further month. This pricing of futures is known as contango, and it happens 80% of the time. This means that 80% of the time, NYSEARCA:UVXY has a negative drag to it. Yuck.
Volatility is TOUGH to Get Long
We spoke earlier about how there was no product, service, earnings, or balance sheet to look at when considering NYSEARCA:UVXY. This is also true for the VIX and a stock like VXX.
Because none of these products have any fundamentals about them, in order to get their prices, those who manage these volatility products must look at the Vix futures prices to determine the pricing of these volatility stocks and ETF’s.
As we have shown you and spoke about for the last few minutes, the VIX futures are “stuck” in contango 80% of the time. This means that these products are going to have a difficult time moving higher as the front month Vix futures contracts decrease in value a lot last than those further away from expiring.
Because of this, we do not recommend ever getting long a volatility product, which includes NYSEARCA:UVXY.
How We Trade UVXY
Again, while volatility does go higher from time to time, it is very difficult to make any money from it because its products have a nasty negative drag against them 80% of the time.
Because of this, we NEVER trade products like NYSEARCA:UVXY from the long side. We could be correct and volatility goes higher, however, if the short term Vix futures do not move higher at a larger rate than the futures further away from expiring, we will not make any money.
We will NEVER trade a product where we can be right in our thinking and timing but do not make any money because of circumstances like described above.
Simply, because UVXY has a negative drag to it 80% of the time, we trade it from the short side!
And since UVXY is such a liquid product, we can trade it however we want!
But there is some bad news because this stock has that nasty contango negative drag to it 80% of the time, there is no stock to borrow (since we are not the first people to figure this out) and get short. So we are only left with options.
Which for us…is a good thing! In fact, we ALWAYS prefer to trade options over stock.
Getting Short UVXY
We see NYSEARCA:UVXY as somewhat of a takeover stock as it has the potential to double before you wake up in the morning. Because of this, all of the risk is to the upside. That risk makes this challenging if we are only going to trade this from the short side.
We will not sell naked options in UVXY because of the takeover risk. However, we are more than happy to sell or buy spreads!
Let’s look at an example trade we would make in NYSEARCA:UVXY.
With the stock currently trading at $17.51, we are looking to sell the 17/18 call spread expiring in 53 days.
In doing this trade, we are going to collect $0.33 and have to put up $.67 in margin requirements.
If UVXY expires 53 days from now below $17.33, we make money!
We can see our breakeven in $17.33, our max profit is $33, and our max loss is $67. If we are right, we can make almost a 50% return on our money in 53 days. Not bad for a product in which we know we have a slight edge 80% of the time.
Wrapping it all Up
That was a lot! Here is what we covered in our ultimate guide to trading NYSEARCA:UVXY.
- UVXY is an incredibly liquid product so we can absolutely trade it
- UVXY is supposed to be a triple leveraged Vix product
- UVXY goes down a lot more than the VIX
- Vix products are priced from the first two month futures contracts
- Vix futures are in contango 80% of the time
- 80% of the time, UVXY has a negative drag to it from contango
- We only trade UVXY from the short side and only trade options spreads
There you go…out ultimate guide to trading NYSEARCA:UVXY.
Now get in there are start trading!