Stocks tumble 1.2% and volatility surges 40%! as another Malaysian airplane goes down, allegedly by Ukrainian Rebels. While this turn of events could technically mean I was wrong about Russia not being a big deal, there would have been no way for anyone to have made a profit had they bet against the market or went long volatility following Putin’s invasion of Crimea on February 27th, 2014. So while you can say ‘I told you so’, you have no money to show for it. The S&P 500, for example, is 125 points higher since the invasion. A fund that goes long volatility is still 25% lower than on Feb. 27th, even after the huge spike today. To understand why this is, when you go long volatility you are are essentially buying an insurance policy in the anticipation something bad will happen. This can be replicated with funds that allow you to be the insurer or the insuree. Due to exponential decay, after many months, you will lose a lot of money if nothing happens. The fund that sells insurance or what traders call volatility has done very well – up over 400% in four years. You can buy and sell long, short and medium term volatility or ‘insurance’. Longer term volatility is less sensitive to market events, because of the tendency of volatility to revert to it’s mean over the long term. Let’s pretend the spot or instantaneous volatility (called the VIX) is at 12, which is low relative to the historical average. Because 12 is so low, many people think that volatility will rise in the next month to maybe 13 or so. Because you cannot go long the VIX itself, you can go long the 30-day volatility fund (also known as the short-term fund or VXX), but at the end of the month if the spot volatility stays at 12, you will lose 12/13 or 8%. This is called the contango. The fund that replicates the selling of this insurance benefits from contango and is up 8%.
To lean more about trading volatility, I recommend these sites:
sixfigureinvesting.com A lot of good content here that explains contango, volatility funds, and various strategies.
http://vixcentral.com/ To see the contango of the different contracts
http://en.wikipedia.org/wiki/Volatility_%28finance%29
Here is the performance of a fund that sells medium-term volatility:
Up about 300% since 2011 versus 60% for the S&P 500
On the other hand, the fund that goes ‘long’ medium-term volatility has lost about 75% of its value.
Anyway, the sell-off wrought by this downed airliner is just anther buying opportunity. Going back as far as WW1, there is not a single instance where military and foreign policy conflict resulted in a deep, prolonged slump in stock prices, including and not limited to: two world wars, Vietnam, Mogadishu, 911, Iraq civil war, Iraq–Kuwait war, the Cold War, Cuban Missile Crisis, and many more… Google just reported another great quarter. You think the people in the Googleplex care about Russia, besides as a conversation piece? How about Facebook and Spanchat. No one losing sleep over there, either. As Obama the empty suit threatens sanctions, Putin will laugh it off. Same for Wall St.. In a few weeks no one will care anymore. No matter what happens between Russia and Ukraine, people will still be clicking Google ads and posting pics on Facebook. They will be taking selfies with Snapchat and playing Candycrush. They, the consumers of social media, are the heroes of the economy and America, not the liberals who fan the flames of crisis to make the market fall.