Profiting from a bear market
In the explore part of my core-and-explore portfolio, one idea is working well in this bear market, delivering an average gain of 25% on 1- to 2-month trades since October. BTW, this strategy is not for everyone - capital losses can occur.
It is based on the CBOE Volatility Index (VIX), which measures the level of fear in U.S. stock markets. As can be seen in the chart below, VIX mostly moves between the lower boundary of 10-12 (low fear) and the the upper boundary of 30-32 (high fear). The VIX has climbed to 40 or higher only five times since 1990.
The strategy is to buy call options on VIX when it falls close to its lower boundary of 10-12 and buy put options when it rises to or above the upper boundary of 30-32. The better bet is put options because VIX usually retreats fairly quickly from fear spikes.
The gains to date are mostly due to buying puts and taking profits early. I would like to let the profits run but persistent bearish sentiment in 2022 means the VIX is not likely ready to go into an extended downtrend just yet. I use three-month maturities for the options and try to roll them over after a month or two to reduce time decay.
What next? I’ll take a breather from buying puts at the 30-32 upper boundary and wait for the VIX to rise above 40 before buying them again. Why? The upward trend in the VIX during 2022 suggests higher levels are coming. I also respect Michael Burry’s due diligence, so when he says the S&P 500 has a lot more to fall, I tend to listen.
I don’t know how long it will take for the bear market to bottom but the opportunity to pick up VIX puts in the 40 to 60 range should be big. This VIX approach was first discussed in my Oct. 21 post.