N o one can deny that volatility trading has become incredibly popular with traders and investors. Not so long ago the concept of trading pure volatil

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3 N o one can deny that volatility trading has become incredibly popular with traders and investors. Not so long ago the concept of trading pure volatility was little more than a curiosity and understood by a select few, at least at the retail level. Before the onset of VXX, SVXY and other similarly listed Exchange Traded Products (ETPs), volatility of course could be accessed via regular listed options. Think option pricing will compress? Sell a straddle or strangle, or just a call or put, right? Sure, but taking a view on shorting volatility via options can present pathdependence and strike risk issues - meaning you could sell a strangle, for example, and be correct in your assessment that market movement and option pricing will contract, but still be wrong because the underlying equity marched steadily upwards through your strike and breakeven price was a great example of how that happened virtually every month a low volatility year by definition but directionally straight up for most global markets. So you were right but you were wrong! And in trading losing money is just plain wrong. Enter one of the more unique financial creations of the past 20 years VIX Futures based ETPs. Imagine the ability to take a view on the direction of volatility without having to worry about the underlying strike risk, or the directional movement of an underlying stock or index. That s what we mean about trading pure volatility. You don t need special credentials like options and futures licenses to trade these ETPs. They trade on the exchanges just like any other stock or ETF. When we go long them we benefit from defined downside exposure, and trading them doesn t require a margin account. VXX is the ipath VIX Short-Term Futures Index ETN a long position in VXX gives you long volatility exposure. Buying and owning VXX establishes a long-volatility position. SVXY is the ProShares Short VIX Short-Term Futures VIX ETF a long position in SVXY gives you short volatility exposure. Buying and owning SVXY establishes a short-volatility position. To be clear, you are not shorting the ETN - by buying it you are establishing a short-position in volatility. So if you think actual volatility (observed movement) and implied volatility (option pricing) are going to rise or fall you can bet on those outcomes via a long position in these products. We will talk about some very important features of these products

4 that you simply must know before you trade them. Moreover we are going to learn that these ETPs are unlike any company or business that you might otherwise purchase in the equity market. In fact they are not companies at all. They are in a sense just mathematical proxies for a structural behavior that should play out in a fairly predictable way over time. These ETPs are essentially structured to go in one direction most of the time. If someone told you of a listed product that was basically made to move towards zero over time would you believe them? I can assure you that very few products like that exist. But would that represent an opportunity? Absolutely. That is powerful knowledge and that s what VixHunter is here to help you understand. Now, is the ride always smooth? No, in fact at times it can be uncomfortable. But we at VixHunter believe there s a better way to approach things. Results are important, but being able to sleep at night is equally important. Keeping track of market stresses and structural edge is paramount to recognizing what kind of volatility environment we re in. In so doing we can adjust our position weighting or add other forms of protection as needed. While capital preservation should be a focus for all investors and traders, it is critical to us. Imagine for a moment that volatility trading is like flying a Cessna aircraft. When the skies are clear and the winds are light flying in a straight line is actually quite simple. Hold the control wheel steady and the darn thing wants to fly itself. Sometimes short-volatility can seem easy when conditions are benign but it s when storm clouds appear that the pilot earns her money. Well executed entry and exit points (take-offs and landings) are crucial to making volatility work for you in the long run. Correctly assessing rapidly changing market conditions is the secret sauce to being successful over time. That s why having an expert co-pilot in the cockpit with you is key.

5 So why do so many people take the traditionally more difficult side of the trade, ie long VXX? Well, to be fair to some of them we have to qualify the word wrong. Is it wrong to lose your house insurance premium each year despite not having made any claims on it? No, of course not we re happy to lose that money year after year because it serves an important purpose. It gives us peace of mind knowing that one of our most valuable assets is insured against loss in the event that something tragic happens. That s money we re happy to lose, isn t it? In the same sense we accept losing money on protective puts for our long market portfolio. And that s how some folks are able to use VXX in the more correct fashion, as a hedge of sorts to protect their portfolio, for example, to carry them through an important event or seasonal period. I say more correct since there are much better ways to hedge the downside in your long equity portfolio but that s a conversation for another day, and something our team can also help you with. I hope I ve piqued your interest, dear reader. And don t worry, we ll go over these concepts in detail. Don t be too intimidated - understanding options and volatility is a little like becoming familiar with a new language. Remember that feeling in school when you got the meaning of something but only a moment later it seemed alien to you? I remember learning these concepts 22 years ago and recall that it would make sense one minute and then I would lose it. So repetition is the key to embedding something into one s brain. In our writings and webinars we ll keep going over things and eventually you ll say Eureka, I ve got it!. And if you like how we think you can let us have all the headaches and can just follow along with the VixHunter Trading System. In the meantime let s explore this wonderful world of opportunity together. Let s continue to layer our knowledgebase. Let s talk about the granddaddy of volatility measures, also known as the Fear Gauge, the Chicago Board Options Exchange Volatility Index, the VIX. It has been around in one shape or form since It updates continuously and is meant to give us a picture of the expected volatility of the S&P500 Index over the next 30 days. You can also think of it as a proxy for the cost to insure a basket of S&P500 equities in the near term. It s calculated a little differently now than it used to be but suffice to say that it monitors the implied volatility on a combination of calls and puts in SPX (S&P500) Index options. In doing so it reflects a level whereby participants are willing to buy and sell insurance for their portfolios.

6 Now, what s implied volatility? It s a relative measure of how expensive options currently are. It reflects the market s view of how volatile that particular underlying stock or index could be. Why do some options seem much more expensive than others? Let's relate it to something most folks have already encountered in their lives auto insurance. As an example: two men are looking for insurance for a shiny new red sports car. One man is 25 years old with a few speeding tickets. The other is 45 years old with a clean driving record. The older gentleman is quoted $1500 a year in premium but the younger one is quoted $4000 a year. What gives? They both live in the same part of the city and want to own the exact same car. Well, one individual carries a higher risk of accident. The insurance provider wants to be compensated for taking on the more elevated risk that the younger driver will get himself into trouble. How can the insurer know this historical risk? Well, for one it looks at the individual s driving record, but it also can look at the record for the average 25 year old that owns a similar flashy car. It asks itself: how many accidents and speeding tickets are typical for someone like that? The insurer is looking at past realized volatility (also called historical volatility) to help determine where current policies should be priced. Option traders do the same thing we look at past movement in Tesla s stock, for example, to help determine how fair current pricing is. So the difference between $1500 and $4000 is what we call a difference in implied volatility. Both auto policies cover the same $100,000 vehicle, but one premium implies a higher potential for a claim. In market speak, the higher premium implies a potentially more volatile performance by the younger man. Similar to how Tesla option prices are relatively higher and generally imply a more volatile performance than those of GE or Johnson and Johnson. In Tesla s case the seller of those options

7 is demanding a higher price for the possibility of more elevated market movement going forward. So while there is no possibility of an actual car accident, per se, we express risk in the equity options world as the possibility of movement. This movement can be up or down, so it doesn t imply a direction but merely a measure of expected movement around where the market is currently trading. And the reason we call the VIX the fear gauge is because when it is rising it is telling you that option sellers are more worried than usual and therefore are asking for higher premiums for puts and calls (mostly puts). Why? Perhaps the market has been already been showing weakness or there s an important or worrisome approaching news event - but for whatever reason the cost of insurance has gone up. We can see that over time the VIX is generally negatively correlated to the stock market. When there is calm in markets it tends to drift lower. When there is upheaval it tends to rise, sometimes very sharply. So what we are beginning to realize is that there are two key measures of risk and volatility that we need to monitor. 1) Realized volatility (historical), which looks into the past, and 2) Implied volatility, which estimates future movement

8 The two work together over time. They can absolutely diverge, which creates opportunity for traders, but over time they should follow each other around. The acknowledgement that option pricing is a relative value concept begins to make more sense when we consider how these forms of volatility work together. A VIX level may be low or high from the standpoint of a historical range for that index (ie, it typically trades between 10 and 30), but at any given time it may or may not be cheap or expensive. To know this we need to assess how volatile the market is or has been. A VIX of 12% movement (the VIX is really a percentage) may be low within a recent range but quite expensive if the market is only moving at 5% (as we saw for much of 2017). A VIX of 20% might in fact be cheap if markets are swinging around dramatically. Remember, low and cheap, or high and expensive, aren t necessarily the same things in the world of volatility. The VIX is also a mean reverting measure. Remember, the VIX is not a share of a company, it s merely a statistic. But that number still has meaning at any given level. A VIX of 11 it is telling you that the options market is implying around 0.69% of daily market movement in the S&P500. When the VIX is 32 option participants are expecting around 2% of daily market movement. That s a big difference, and a good reason why very high levels of VIX are difficult to sustain. A VIX of 32 implies 2% of daily close-to-close market movement for each of the next 22 or so trading days. We can concede that a 2% market move is not uncommon now and then, but consistent daily movement like that for an extended period of time is less realistic. So a VIX of 32 and above is generally very difficult to

9 sustain. As cooler heads prevail in equity markets, we see that VIX invariable drifts lower. Similarly very low levels of VIX tend to be unsustainable for very long periods of time. But having said that, we find that mean-reversion as a concept is less useful at the low end to most traders. While spikes in the VIX are sometimes met with follow through and continued choppy movement for some time, they are mostly digested and ultimately fade. Selloffs in VIX, however, can often be very prolonged. And while the average, or mean, for the VIX over the past 25 years is around 19.25, the fact is that the Index does spend a great deal of time below 15. This is very useful information to option and volatility traders. To think that each time the VIX hits 11 or 12 that it will be zooming back up is looking for trouble. The VIX can spend months without a tick above 13 or 14 don t underestimate how long quieter periods can last. Options and futures are instruments with a limited lifespan. When trading them be sure to adjust your expiries accordingly. Moving along, the key to the concept of insurance is that it may be correct or incorrect in assessing risk it s merely a form of educated sentiment. Markets rarely hit the nail on the head when pricing future movement, and we don t ultimately know how correct the assessment is until the period plays out. So this gives rise to the concept of the Volatility Risk Premium (VRP), which is the difference between how much someone pays for insurance and the fair value of that insurance based on what actually happens in the equity market. This is an incredibly important concept that serves as one of the crucial building blocks in our knowledge of how volatility products like VXX and SVXY behave and relate to reality. We talked about looking at historical volatility to assess possible future movement in a stock or Index. What happens if option pricing ultimately ends up having been priced too high? Buyers of that insurance, on balance, will have lost money, and sellers will have profited from selling it. In practice we find that most of the time folks pay a little too much for insurance, which translates into a profit to option sellers (the VRP). Source: EatonVance Does the fact that insurance is more often than not priced too high mean that it never pays off? Of course not, we know full well that occasionally it comes in

10 handy. But sellers (insurance underwriters) tend to skew their pricing higher to maintain a cushion for risk and profitability. In equity markets this concept is similar. Implied volatility tends to be priced higher than realized volatility. And downside puts tend to be skewed higher than strikes that are closer to the money (strikes that are near to where the index is trading). This is due to the fact that most participants buy insurance there is a natural flow to purchasing protection. Risk-takers, or option sellers, demand a premium to take on the other side of that risk. In fact, across asset classes the VRP tends to most pronounced in equities. This makes sense as risk-on sectors like equities tend to attract more hedging by managers. Investors and large institutions like insurers are happy, or even mandated, to offset risk to both protect gains and smooth out returns. As a result the VIX tends to trade around 1.5% to 2% higher than realized movement on average. So to put it in simple business terms, as a volatility seller, if I can sell $500 worth of risk for $600 I ve got a trade. And if I can create a diversified portfolio of many trades like that - over time I ve got a business. Now, notice one important word in the title of the VXX ETN: Short-Term Futures Index. This is incredibly important as we learn more about these products and realize that their values are not derived directly from the VIX that you hear about on television, but on the VIX futures themselves. The VIX can t be traded. Think of it as a complex and ever-changing calculation that is based on ever-changing strike weightings throughout the day. It would be almost impossible to replicate using listed options. So years ago someone had the interesting idea to create an exchange traded note that would replicate the behavior of VIX as best possible. How? Enter VIX futures they are indeed tradeable! VIX futures have exploded in popularity since the Financial Crisis of 2008/2009. So jarring to investors was that event that the concept of hedging began to take on a great deal of importance in capital markets. For some reason folks tend to rush out and buy insurance after the roof catches fire! In any case, someone imagined that an ETP wrapper that effectively holds VIX futures would give a good approximation, over time, of how the VIX might act. So to make the concept work the funds would need to either hold or simply track short-term futures. The only issue was that futures are instruments with limited lifespans. So to make it work they devised a methodology to not only hold futures but to roll them each day into the following month. So VXX targets a ratio of first and second month VIX futures in order to

11 approximate a constant maturity blended future of 30 days. Because futures are rolled before they expire the fund never expires itself, thereby providing a product that is consistently long short-term VIX futures. Now, most of the time the structure, or shape, of the VIX futures curve is in what we call a contango meaning upward sloping (as seen above). We typically see this in periods of calm as the futures rise throughout the term structure with each subsequent one trading at a higher price. This upward sloping shape is partially due to the fact that in the short-term volatility is likely to remain low, yet in the longer term participants expect some event to test the market s resolve. This premium to VIX is called the Futures Risk Premium (FRP). The daily mechanics of selling the front month future and buying the second month at a higher price creates a kind of negative roll-yield. In truth, it is the fact that futures owned by the strategy are eroding daily and ultimately being replaced at a higher price that ends up costing money. Regardless, similar to the VRP, this FRP this represents a loss for products like VXX (and more for UVXY). Now we re starting to work towards understanding why the long-term VIX chart looks so different from the VXX chart. This concept has been confounding novice volatility ETP investors as they think the two products are essentially one and the same. While it s true that they intend to tell a similar story they in fact are quite different in fundamental and structural ways. The differences are exactly what get many investors into trouble. The VIX is a snapshot of volatility that re-snaps throughout the day. It takes volatility compression into account, but only to a certain

12 point. Typically volatility at the 30 day mark finds a floor and thus VIX also finds a floor of between 9 and 11. VXX does not reach any such floor. As I mentioned earlier, periods of low volatility can persist for many months, or even longer. So it is at the very moment that investors think VXX should be bottoming out that headwinds are oftentimes the most severe for that product. It is at this point that the buy-the-dip VIX crowd pounds the table telling folks to buy buy buy.! Yes, at some point they ll be right again, but in the meantime VXX will roll itself into oblivion. This relates to our earlier point about quiet periods lasting longer than expected. What is typically happening when the VIX is 11? Markets are calm, futures contango is steep, market movement is anemic and negative roll yield plentiful. That is a recipe for further losses in VXX. I don t know about you but I m not a huge fan of fighting the market. There is nothing incorrect in the way that it acts, but folks need to realize that the product loses money in a similar way that the act of buying short term puts loses money month after month. And importantly, that money is gone. Let me mention that one more time it is gone forever the money lost to roll-yield disappears so that any subsequent run up in VXX (VIX futures) will have great difficulty making up for what has been lost. Despite the fact that VXX is down about 99% since inception we can see that investors continue to pile into it. Increasingly, however, hedge funds and institutions are also looking to profit from volatility as a standalone generator of returns, and this is what VixHunter.com is all about. It s about understanding the structure of these products and how consistent the profit edge is in this arena. The fact that so many people don t understand how these products work merely helps to create opportunity for our members. Even Robert Whaley, the creator of the VIX index,

13 expressed with some incredulity and concern at how surprisingly destructive an illtimed holding of VXX could be in one's portfolio this is a testament to its hidden complexity. But hidden no longer to our subscribers. Now, when the VIX futures curve is in backwadation, the slope of the curve is reversed. Futures prices begin high in the near months and drop. This shape typically occurs when there is a fair bit of worry in markets. The mechanics of the futures roll begin to add value to VXX instead of hurting it. These conditions are less frequent but do occur from time to time. In these times the structure we often refer to is impacting our positions (depending on what they are) in different ways. Now, this leads us to SVXY. For the short-volatility strategy contango represents a positive tailwind as measured against VXX - to the tune of 50% of the VXX percentage move. Hence the term inverse. Negative roll yield for VXX becomes positive for SVXY. So you may ask, if VXX seems to erode forever wouldn t the inverse product benefit from that forever? Yes and no. It will as long as it stays solvent. Most of these inverse products contain Termination Event clauses in the prospectus. * These need to be respected. If the blend of the front two VIX futures rises 80% in one trading session the creator of the product can elect to suspend or terminate it. This is done since our loss as investors is limited to 100% percent of what we have invested. Yet the investment bank that manages the inverse product is short futures and these can of course continue to rise and hurt them. So they give themselves an out in the form of a suspension in order to unwind those positions. All the more reason to have VixHunter on your side, making every effort to watch for signs that something profound could be amiss.

14 This was a lot of information dear reader, so let s summarize: So what do we have working for us as we position opportunistically in SVXY, VXX or cash? 1) Roll-yield and futures drift gains. When markets are quiet they can stay quiet for significant lengths of time. A number of traders on the VixHunter team have traded volatility for more than 20 years (one since right before the crash of 1987!). All of us remember the mid-1990s, the mid-2000s, and the mid- 2010s. I recall feeling that those quiet periods would never end. VIX spikes can happen but low levels of volatility need to be respected just as much since they have real staying power. These periods exist close to 85% of the time and can be beneficial as negative roll yield and ever eroding VRP persists. 2) When markets become more volatile we are relying less on term structure, but we now take advantage of something that is also important the tendency for option pricing to mean-revert. In other words, it s easy for stocks to stay down, but it s difficult for option pricing to remain high for long. While we may have taken some amount of strategy drawdown due to rising volatility (hopefully our indicators had us go to cash or VXX), we are now betting on a different sort of structural advantage the tendency for fear levels to dissipate (remember mean-reversion?). And it s precisely in these times that VXX positions can be monetized and cash held or deployed to SVXY. Roll yield gains are a slower and consistent form of return when conditions favor them. But a return to the mode in volatility can potentially be a larger and more rapid gain as VIX futures plunge and then experience a volatility hangover as we enter a quieter period. Remember it s difficult for the VIX to stay at 30 or 40 that implies an amount of daily movement that is simply difficult to sustain. Even if stocks don t bounce back much from a large selloff, you can bet that at some point the VIX will compress. Think of this as a form of behavioral-edge. We come by it less frequently but it can be a very powerful generator of returns and bounce-back to the strategy. 3) In times of stress or uncertainty we can also move into VXX when our proprietary risk measures are indicating as such. While conditions favoring short volatility are much more prevalent, we must always respect the picture

15 that we re observing. Volatility begets volatility short squeezes can be violent and sustained. We do see markets returning to a more balanced level of volatility in future years following the unnaturally low and stimulusinfused calm that we ve seen more recently. 4) And of course good old cash is very much a valid position. At times we will sit and await a better entry into volatility positions. The fact is that many investors don't understand the mechanics of VXX and SVXY they notice the VIX trading down around 11 or 12 and they assume that because VIX tends to historically bottom out in that range that VXX should too. But the good news is that the mechanics behind how short-term VIX ETPs are structured and react lend credence to how these opportunities will persist and potentially give us great opportunities for years to come. The team at VixHunter.com can guide you. Sign up for our 14-day free-trial, we think you ll be glad you did. If you only come away with some useful knowledge then frankly that s a win for both of us. We love to teach and we it love when folks strive to become better traders and investors. If you want to stay on for potentially amazing gains and education, even better! See you soon. VIXHunter.com Volatility, Solved.

16 Disclaimer: This ebook, the VixHunter.com Trading System are for educational and research purposes only. Anything in this document or found on the VixHunter.com website is not to be considered investment advice. The information, facts, figures, data and analysis included herein are believed to be accurate and credible but nothing can be verified for its certainty. The principals of VixHunter.com actively trade a wide range of Exchange Traded Funds (ETFs) and Exchange Traded Notes (ETNs) and positions referenced herein. These may change at any time. Any performance data is hypothetical and for informational purposes only. Since many potential factors including, but not limited to; market conditions, brokerage service, buying power, trading skills, stock availability will vary from trader to trader, individual results may vary. No representation is being made that any account will or should achieve profits or losses similar to any shown in any publication, system, article or webinar. Educational material provided by VixHunter.com does not, nor cannot take into account the needs, objectives and financial situation of its subscribers. You should consult with a qualified financial advisor before making any financial decisions. By attending or viewing any VixHunter.com information in any medium, you acknowledge, submit and adhere to this disclaimer and accept the liabilities incurred your own decisions while using our information and analysis at your own risk. Click here ( to learn about the difference between Exchange Traded Notes (ETNs) and Exchange Traded Funds (ETFs) Important Disclosures and Disclaimers regarding Leveraged and Inverse ETFs: FINRA has made the following statements concerning leveraged and inverse ETFs- "Exchange Traded Funds (ETFs) that offer leverage or that are designed to perform inversely to the index or benchmark they trackor both-are growing in number and popularity. While such products may be useful in some sophisticated trading strategies, they are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective. Therefore, inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets." "These products are complex and can be confusing. Investors should consider seeking the advice of an investment professional who understands these products, can explain whether or how they'll fit with the individual investor's objective and who is willing to monitor the specialized ETF's performance for his or her customers." "Leveraged and inverse ETFs can be appropriate if recommended as part of a sophisticated trading strategy that will be closely monitored by a financial professional." VIX futures based ETPs are highly volatile products and not suitable for every investor. Read each and every prospectus carefully and understand the risks before investing in these products. Please refer to Termination or Acceleration clauses and understand them thoroughly. Important Disclosures and Disclaimers regarding Options: U.S. Government Required Disclaimer- Options involve risk and are not suitable for all investors. Before trading options, please read Characteristics and Risks of Standardized Option (ODD) which can be obtained from your broker, by calling (888) OPTIONS, or from The Options Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, IL The content on this site is intended to be educational and/or informative in nature. No statement on this site is intended to be a recommendation or solicitation to buy or sell any security or to provide trading or investment advice. Traders and investors considering options should consult a professional tax advisor as to how taxes may affect the outcome of contemplated options transactions. Stocks, forex, futures, and options trading is not appropriate for everyone. There is a substantial risk of loss associated with trading these markets. Losses can and will occur. No system or methodology has ever been developed that can guarantee profits or ensure freedom from losses. No representation or implication is being made that using this methodology or system or the information in this letter will generate profits or ensure freedom from losses. Any trade mentioned at VixHunter.com is not advice or an order to make any purchases or sales and any trades you make are your decision alone. VixHunter.com s disclaimer applies to all material published by VixHunter.com including options, VIX and

17 leveraged ETP information. Please carefully read the Disclaimer, Terms of Use, and Privacy Policy at VixHunter.com before purchasing anything from VixHunter.com. Earnings Disclaimer We have made every effort to accurately represent our products and services. The representation of the potential of our products and services is subject to our interpretation. While the earnings potential for those people that use our products and services is usually very encouraging. You acknowledge that your earning potential is subject to many independent factors, all of which vary from individual to individual and are often out of any individual s control. As such, we make no warranty or guarantee of any kind that you will experience any specific level of earnings by using our products and services. Any examples we have provided should not be interpreted as any guarantee of earnings. We do not assert that our products and services represent a "get rich scheme." Upon request, we may assist you in the verification of claims of actual earnings and/or examples of actual results achieved, though we are under no obligation to do so. However, we cannot and do not offer you any direct financial advice, nor are we responsible for any financial decisions you make. As always, it is your sole responsibility to discuss the legality or financial soundness of any decision you make with a qualified professional before making such a decision. Forward-Looking Statements Information found in our products and services may contain information that includes forward-looking statements as defined by the private securities litigation reform act of 1995." We base any forward-looking statements solely upon our expectations on events that have not yet occurred. You can easily identify such statements, as they do not relate specifically to any facts, whether historical or in current day. These statements use words such as "anticipate," "believe, "estimate," "expect," "intend," "plan," "project," and other such words that imply similar meaning in connection with a description of potential earnings and financial performance. Any and all forward-looking statements used with our products and services are solely based upon our opinion of earnings potential. As there are many factors that will determine your actual results, we make no guarantees that you will achieve similar or any results from your use of our products and services. MY NOTES:

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