I’m checking in on the UVXY puts today.
music selection: “Slow Ride” — Foghat
Back on 9SEP2015, I purchased UVXY170120P00005000 for 1.40 a contract. There has been some volatility since and the price has fallen to 1.20 (yesterday’s close). December is traditionally a low volatility month for the markets and I expect to make most of that up by year end.
I had a request a few weeks ago to review why these UVXY puts are my highest conviction idea. The short answer is “contango”. That is the term economists use to describe the normal state of affairs in futures pricing. You see, futures have Time Value the same way options do. The further out your futures contract is for, the more Time Value you have to pay for. So most of the time, a further dated future will be more expensive than a shorter dated one.
UVXY is constructed to follow the *daily* price movements in VIX futures. It does this by buying the futures both 14 days and 40 days out. It rolls these contracts daily. Thanks to contango, most of the time that means selling a “cheap” asset (the near dated futures) to purchase one more dear (the 40 day futures). The fund loses money on almost every transaction! The misery is compounded by the double leverage this fund uses.
Over short periods of time, UVXY can spike. Futures pricing is based on expectations and if expectations are for greater volatility in the present than in the past, the 14 day futures can exceed the price of the 40 day ones. This inverted pricing is known as “backwardation” and it is a fact in the VIX markets about 10 percent of the time. So the price can rise but because of time value, the fund makes less on each winning trade than it should.
Don’t short UVXY directly or sell naked calls! You can end up called away early during a volatility spike and lose more than you originally put at risk. For example, last month the price moved from 24.64 to 39.81 in the space of about a week. If you were holding a short position, it would have lost about 62%. In periods of steep volatility like that, shares available to borrow become scarce and you can end up having to buy back your shares at the worst possible time. If you had written naked calls, the 62% loss would be magnified by powerful leverage. Don’t be a dumbo T.Rex. Buy the long dated LEAP puts and be patient. UVXY will decline at least 60% a year and sometimes as much as 95%. Your time will come.
Devour your prey raptors!