Why September is the Best Month for the Long Volatility Trade
Traders, gear up, it’s that time of the year again – it’s time for the long volatility trade.
Summer markets are categorized as low volatility, boring, drifting and uneventful. This is because professional traders take time off and vacation with their families, leaving the controls on auto pilot.
However, as we get past the labor day weekend, markets come roaring back with a vengeance and we start to see a battle for position between buyers and sellers. This past week has been transitional for markets, as sellers are pressing new lows on increasing volume. More selling means higher fear being priced in, which leads to more uncertainty and higher volatility.
Let’s start with some volatility statistics, using the VIX symbol (Volatility of SP500 Index Options):
2015: Aug 18th to Aug 24th (389% pop in VIX)
2014: Sep 2nd to Oct 15th (213% pop in VIX)
2013: Sep 19th to Oct 9th (148% pop in VIX)
2012: Sep 14th to Oct 23rd (129% pop in VIX)
We can see that the trend has been more pronounced in the last few years, however, we cannot forget that the 2008 financial collapse started in a similar way. The volatility jumped over 500% in that year, and it started with the end of the summer market period.
In preparation for this market seasonality, we are gearing up for a great end of summer trade.
Below is a chart of seasonal volatility in the past 26 years.
The Long Volatility Trade
We will be doing a bull call debit spread, using options on the VIX. This is just a sample trade setup, and can be tweaked and adjusted to your own strategy.
Long Oct 18th 13 Call Option @ 4.00
Short Oct 18th 22 Call Option @ -0.95
Net cost: $305 / contract (4.00 – 0.95)
Each spread purchased would cost a total of $305, and can be scaled depending on your account size. We like to hold these spreads until expiry, so we would be risking the full premium.
We only use a 2% risk per trade. So in this case, someone with a $50,000 account can risk $1,000 of capital, and can purchase a total of 3 contracts. One way to increase the contract size is to reduce the risk, by deciding to sell the contracts and close the trade if the price drops to $150 or less. That would allow you to do 6 contracts, as your risk is now only half.
Profit from the Long Volatility Trade
Each spread has a maximum return of $900 ( (22 Call – 13 Call) x 100).
Minus the cost of each spread at $305.
Net profit potential per contract: $595 ($1.95 reward for each $1 of risk).
No trade is a guaranteed trade, and markets do not repeat – but they sure do rhyme. Based on statistics, this late summer long volatility trade is a high probability setup, and a great way to hedge some of your portfolio against any uncertainty over the coming few weeks.
Using a debit spread is one way to reduce your capital usage, and to allow you to earn a high return.
This is a trade we are opening up in our live accounts and scaling up the position to add to the winner, but keeping a short leash on the loser.
Scared of uncertainty and volatility?
Don’t be anymore – now you can make it pay you. The long volatility trade is also very effective in periods of increased uncertainty, like the BREXIT referendum that took place in August of 2016.
Learn how to make more money by trading in down markets.
Let us know how you trade through high volatility in the comments below.
The information contained in this post is solely for educational purposes, and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable to your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.