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Options Theory: 6 Tips for a High VIX Environment

January 28, 2021

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Wednesday saw sellers send a shot across the bow. The S&P 500’s 2.4% was not insignificant, but it hardly warranted the third-largest spike in the VIX we’ve ever seen. Indeed, I find the Fear Index’s 61.64% jump a bit of a head scratcher. Usually jumps in volatility of that magnitude are reserved for situations where the market is down more like 4% to 5% on the day.

Seems like a lot of drama for such a run of the mill market whack, no?

I’ve seen a few interesting tweets on the potential implications, but I don’t have a strong opinion on the short-term direction of the market. Rather than guess if the overblown spike is bullish or bearish, I think the easier takeaway is that we should all prepare for higher volatility in the market.

Just in case.

$VIX chart

Look, I’d love for the SPY to rip to a new high like nothing happened, but not every VIX surge goes quietly in the night. Some linger. And, to be honest, I don’t think the market chopping around for awhile is the worst thing in the world anyways. Many indexes remain extended on the weekly time frames. Some backing-and-filling will allow us to digest last year’s gargantuan gains and build a base for the next leg higher.

In last night’s S.T.E.P. Mastermind group meeting, I highlighted my favorite techniques for trading during a market correction. Usually, I trot them out when we break the 50-day moving average and the S&P enters a downtrend. We’re not there yet, but if Wednesday’s low gives way ($3940), I think the market would be dicey enough to start using these.

The 6 Tips

1. If in doubt, stay out. Not losing is a winning in adverse markets.

2. Reduce my risk per trade by 50%. If I normally risk $200 per trade, start risking $100 per trade. Not willing to sit completely out? At least shrink your bet size if you must play during wacky times.

3. If the VIX spike is followed up by the indexes breaking 50 MA and old support zones, then get more proactive with bear trades. Duh!

4. Scale-out. Profits today could be gone tomorrow. High VIX markets create more overnight gaps.

5. Scale-in. Patterns are more prone to failure. That means you get lots of chances to enter at a better price, but only if you aren’t already in a full position.

6. Favor high probability credit spreads/naked puts over aggressive directional trades. Chop favors theta over delta.

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One Reply to “Options Theory: 6 Tips for a High VIX Environment”

  1. MichaelProkop says:

    Tyler, thank you for these essential tips!

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