Volatility scares a lot of traders.
When wild price swings come out of nowhere, they panic. That leads to bad investment decisions.
But to be a successful trader, you need to know how to take advantage of market volatility.
I’ve been trading for 40 years, and I’ve seen my fair share of volatile events.
That includes everything from the 1987 Black Monday crash to the 2008 global financial meltdown and the 2020 Covid crash.
And I strung together a streak of 20 consecutive profitable years during my hedge fund days.
So when volatility picks up, I’m ready to pounce.
This is especially important right now because I expect stock market swings to pick up as we approach the New Year.
Here’s how you can track volatility – and how I put volatility on my side…
How to Track Volatility
The CBOE Volatility Index (VIX) is a popular tool for traders. It reports expected volatility in the S&P 500.
That’s why some call it Wall Street’s “fear gauge.” The VIX usually jumps higher when the S&P 500 pulls back.
That’s because daily price movements pick up when the stock market is selling off. Conversely, the VIX tends to be the lowest when stock prices are steadily grinding higher.
And here’s something else to note about the VIX’s behavior… VIX will often transition dramatically between “low” and “high” volatility environments.
Look at the weekly chart of the VIX going back 30 years to see what I mean:
The dashed line on the chart is the long-term average of the VIX around the 19 level. Notice how the VIX will spend long blocks trading above or below 19.
When the VIX is below 19, we tend to get calm periods in the stock market. You often see low volatility when stocks are rising.
When the VIX is above 19, price swings really pick up. We often associate these times with events wreaking havoc on the stock market.
I’ve highlighted three major periods of elevated VIX levels over the past 30 years. That includes the tech bubble in the late 1990s, the period around the 2008 financial crisis, and during the pandemic (along with 2022’s bear market).
The past couple of years have seen us transition back to a mostly low volatility environment despite a few bursts in the VIX along the way.
But looking back, extended periods of calm eventually give way to a new round of chaos. That would be signaled by a sustained shift back above the long-term average around the 19 level.
There’s no way of telling exactly when the VIX will jump again. But volatility is currently running near the low end of the historic range.
And we have any number of potential catalysts in the coming year… such as inflationary pressures from the incoming administration that could upset the Federal Reserve’s rate-cutting plans. Various geopolitical pressures and wars could also spawn new concerns affecting the stock market.
That makes a certain strategy to capitalize on rising volatility levels even more attractive.
Here’s how I’m planning to capitalize…
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Using Volatility to Your Advantage
Options are a great tool for using volatility to your advantage.
That’s because rising volatility tends to increase an option’s value (all other things being equal).
And that’s good news for option traders.
Even better is when you buy your option while volatility is low… and sell it when volatility surges. That can quickly turn your trade into a sizeable profit.
For example, back in early August, the VIX soared to its third-highest level ever.
That volatility helped drive a large gain in QQQ puts I recommended to subscribers in my One Ticker Trader advisory.
My readers brought in a 127% gain in just eight days.
So don’t be scared if volatility levels start increasing as we head into next year.
Instead, watch the VIX and use options to turn it to your advantage.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict