Rickards: Volatility Could Explode in a Matter of Weeks
With the changes that have recently happened to the SDR and the Chinese renminbi we are seeing the early stages of the volatility in the currency markets. The currency wars are officially underway.
Volatility is waiting to explode due to unstable currency exchange rates, bank liquidity crises, geopolitical uncertainty, and a wild U.S. election cycle.
One or more of these potential sources of instability are ready to pop-up on the markets like a tightly jammed jack-in-the-box when someone unlocks the lid. The key to profits is to understand how to use volatility as a trading strategy. If you act now, you could reap huge rewards in a matter of weeks.
Most investors have some familiarity with trading specific instruments such as stocks, bonds, and gold. Investors also understand how options can be used to limit losses, and increase gains on trades involving those underlying instruments.
But, volatility is an unfamiliar trading strategy to many. How can you trade volatility? And, how is volatility poised to offer huge gains?
In principle, trading volatility is no different than trading other more familiar instruments. The Chicago Board Options Exchange (CBOE) maintains a proprietary volatility index (VIX). It trades roughly in the range of 0 to 100 although as a practical matter it never reaches either extreme.
A volatility index level of 80 would be associated with something like the Panic of 2008. An index level of 10 would be associated with an unusually calm period of smooth sailing in financial markets. Most of the time the index trades between those levels. Source
As we move further down the path will the IMF be forced to bring gold into the SDR basket of currencies to smooth over the wild fluctuations in the currency markets? These fluctuations could see extremes that the world has never had to deal with in the past and who knows how the “markets” will react.
When you trade volatility, you are not betting on the direction of markets — you are betting on whether or not extreme moves are in store. Those extreme moves could be up or down for a variety of market measures. When you have a long position in volatility, you don’t care if a certain market goes up or down, you just care that markets are jumpy and moving in some unexpected or extreme way.
Of course, when markets are already nervous, the price of volatility (reflected in the index level) skyrockets. The way to profit is to buy volatility when it’s cheap, then reap rewards when volatility suddenly skyrockets due to the occurrence of a market or political shock.
Right now, we see this exact situation. This looks like a great time to play volatility.
Volatility has been historically low in recent months. Right now, VIX is priced at an index level of 15.06. It’s been fluctuating at a low level since last summer, with the exceptions of a mid-September peak index level of 18.1 and a brief spike last week to 17.8.
That mid-September peak was associated with market uncertainty involving Deutsche Bank liquidity problems, the Clinton health scare of September 11, uncertainty in the run-up to the Fed meeting on September 21, and a Trump surge prior to the first presidential debate on September 26. Source
When the 2008 meltdown occurred the smart money stepped back and began making changes. Is this one of the reasons China and Russia have both developed, independently, their own banking systems? Is this one of the reasons China and Russia’s banking system is enter-linked? Since 2008 we have witnessed the banking system being more volatile than ever before. These global behemoths are beginning to show cracks in within their own walls. Will the derivatives market blow apart or will the central banks be able to “save the day”?
All of the concerns that caused the volatility spike in mid-September have abated for the time being. Deutsche Bank appears stable, Clinton appears healthy, the Fed is on hold until December, and Trump in down in the polls.
After spiking last week, the volatility index has now returned to around 15.
Yet, that 15 index level is quite low relative to numerous other periods over the past eight years. Consider the volatility index levels that have occurred in the recent past:
The volatility index hit 79 on October 24, 2008 at the height of the panic of 2008 and in the aftermath of the mortgage market collapse, Lehman bankruptcy, AIG bailout, and the TARP legislation.
The volatility index hit 41 on May 7, 2010, and spiked again to 43 on September 20, 2011. Both spikes were in response to the ongoing European sovereign debt crisis which began in early 2010 (following the default of Dubai World in November 2009), and continued in stages (through the last Greek rescue package in 2015).
The volatility index surged to 28 on August 21, 2015 in the wake of the shock Chinese currency devaluation on August 10 and subsequent plunge in U.S. stock prices, which resulted in an 11% correction. That sell-off was only fully alleviated when the Fed postponed its hoped-for September 2015 “liftoff” in interest rates. Source
If we have a few more weeks, use the time wisely. Continue Reading/Daily Reckoning>>>