Trading Volatility. Using the Strategy. Brennan Nykreim Innoware Prannay Pradeep

Transcription

1 Trading Volatility Using the Strategy By Brennan Nykreim Innoware Prannay Pradeep

2 Trading Volatility Using the Strategy Learn to successfully trade UVXY, TVIX, VXX, SVXY & XIV PJP Consulting LLC. All Rights Reserved. For information about permission to reproduce selections from this book, please contact: PJP Consulting LLC NE 1st Pl Bellevue WA

3 Contents Chapter 1: How I Started 4 Chapter 2: The Basics 8 Chapter 3: Overview of pricing of Volatility ETFs / ETNs 16 Chapter 4: How VIX Related ETFs/ETNs Are Priced? 24 Chapter 5: The Strategy 32 Chapter 6: Why Going Long Volatility Is Usually Unwise 40 Chapter 7: Being Long XIV & SVXY 54 Chapter 8: Shorting UVXY, TVIX, VXX 60 Chapter 9: SVXY Call Options 68 Chapter 10: Buying VXX, UVXY Long Dated Put Options 78 Chapter 11: Selling VXX, UVXY Naked Calls 86 Chapter 12: Selling at the money UVXY Straddles 92 Chapter 13: 20% Portfolio Core Short Position 98 Chapter 14: Cashing Out 1% of Your Portfolio Monthly 116 Chapter 15: Managing Risk When M1 Is Lower Than M2 118 Chapter 16: Managing Risk When M1 Is Higher Than M2 126 Chapter 17: Credits 132

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5 4 Chapter 1 How I Started It was the year 2015 and I had enough savings (to the tune of around $500,000) to be invested in the stock market. Since I was busy working in the software industry and had very little experience in investment, I decided to meet up with my Financial Consultant in the Seattle area. They had been managing a very small amount for me over the past 3 years which was giving a return of around 5% and I was happy with it, since banks were paying 0.1% interest on CDs. I scheduled an appointment with them to see how they could help me improve returns if I transferred an additional $500,000 to the managed account. They quickly replied that if they were to actively manage this large sum on my behalf, I would need to give them the absolute authority to take daily decisions on my behalf. They claimed that if they had the money, they could take decision during the trading day and ensure good use in hopes of a great yield. Though I was a little apprehensive, I decided to give it a try. I ended up transferring the money into two new accounts and signed over control. They immediately invested the money into a mix of mutual funds and equities. I would periodically log into my account to see the progress. First, the portfolio value went a little up. Then I started seeing huge swings in the account value. Up $10,000 one day, down $25,000 the next. I wondered what was happening. Why were they not selling everything when the account value was higher and buying it all back when the value fell. The net result was my portfolio was always less than the $500,000 amount that I had

6 5 transferred. After 6 months, I scheduled another appointment with them. I was told not to worry, just stay the course and things will be fine. Unfortunately, around the end of December 2015, my portfolio value was down by $40,000. I had had enough. I decided to take investing into my own hands. I first made a list of all the tickers I had a profit on. I instructed my financial consultant to sell everything where I had profit and asked them to start issuing me checks as soon as proceeds were realized. Then I noticed that where I had losses, I could not see them recovering at all. So, I made the final decision and told them to sell everything immediately and send me all the proceeds. The accounts were closed. Once I got the principal back, I was still down about $40,000. Turns out they charged a service fee of over $6,000. I decided to lodge a formal complaint with them, since I felt they had misled me. They had promised that they would actively manage my portfolio. Instead, they just followed their computer, invested in a mix of mutual funds and equities and never looked at the account again. Such complaints from retail clients are rare but in the USA, consumer protection is very important. Soon, I heard from the financial consultant s attorney. They wanted me to sign an undertaking that I would not sue them and they would refund the $6,000. I immediately jumped on that offer. I then decided to manage my own investment account. I had already transferred the money to my existing Scottrade account. I chose companies like Facebook, Google, Twitter, Expedia, Under Armour etc. and was slowly able to see the account grow. It was surprising how much better the account was doing compared to the previous firm s efforts. I started learning about options, short selling and leveraged ETFs. There are so many strategies to choose from. Make an investment and hold for longer periods of time. Buy in the

7 6 morning, sell in the evening. Buy today and sell after a week. Buy deep in the money calls. As time went by, I still felt that odds were stacked against me. I would think a particular stock was going up because it had good earnings. Instead, it fell because some analyst had downgraded the stock or investors were unsatisfied with the numbers. Stock prices would fall and it seemed like there was an endless stream of excuses. Like most investors, it became a mission to find a way to increase returns. I noticed that VXX - ProShares VIX Futures ETF - had fallen from around $94 in January 2016 to around $25 in December I looked at it s prices from previous years and noticed that the price had fallen regularly since inception. Also, UVXY - ProShares Trust Ultra VIX Short-Term Futures ETF - had fallen from $4,087 in January 2016 to around $174 in December I also noticed that UVXY started in October 2011 and it s inception price of $41 million dollars (Yes!!! 41 million dollars) had fallen to $174 by December I could not believe my eyes. If only I had focused on such symbols!!! I should have shorted just 100 shares of VXX and/or UVXY on January 1, 2016 and covered them on December 30, 2016, I could have made money with ease. This led me to do more reading on VIX, VIX Futures, more tickers like TVIX, SVXY, XIV, ZIV and of course the basis of them all VOLATILITY. I quickly learned that Volatility mean reverts. Due to geopolitical news or economic news or other events, we could see an increase in volatility or VIX commonly known as the fear gauge. As VIX rises, we usually see most stock prices fall. However, with a volatility spike, some ETFs/ETNs which are based on volatility, will rise. Calm will return eventually and with this, the volatility tickers whose prices rose earlier would fall back and sometimes go below earlier levels. So to make a reasonable return on my investment, I had to do only one thing.

8 7 Wait for the Volatility to rise. When the peak was reached, I need to sell the volatility based ETF/ETN which I can buy back when the calm is returned, at which time the price would have fallen substantially. As my reading on volatility continued, I was very impressed with this statement Volatility mean reverts but Contango losses are forever. Don t worry, in this book, we will explain everything about VIX, VIX Futures, Contango, Selling Calls, Buying Puts in short everything you need to know about volatility trading and even when to go long volatility, if ever. Now I only trade volatility on the short side. I don t have to worry about a CEO resigning or analyst downgrades. When doing volatility trading, there are different risks such as black swan events, and political turmoil that both present risk to the strategy but also provide further opportunities to make money. I will take you step by step into each instrument, how VIX futures affect their prices during the trading day as well as at the end of the trading day, and how to trade each instrument. Now for some disclosures: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. As an investor, you are fully responsible for any investment decision that you make.

9 8 Chapter 2 The Basics The Tickers There are many volatility ETPs (Exchange Traded Funds) / ETNs (Exchange Traded Notes) to choose from. All products come with different advantages and disadvantages depending on trading strategies. The ETFs / ETNs hold VIX futures which are rebalanced after the end of each trading day. The price of the VIX futures determines the NAV (Net Asset Value) of each product. Throughout the day, market participants can buy and sell these instruments, just like stocks. If the NAV gets too far from the fair price, the makers of the ETPs have authorized participants who execute orders to correct the price. While there are many options to trade, below is a list of the most popular volatility based products. VXX - ipath S&P 500 VIX Short-Term Futures ETN UVXY - ProShares Trust Ultra VIX Short-Term Futures ETF stock TVIX - VelocityShares Daily 2x VIX ST ETN SVXY - ProShares Short VIX Short-Term Futures ETF XIV - VelocityShares Daily Inverse VIX Short-Term ETN

10 9 VXX - ipath S&P 500 VIX Short-Term Futures ETN VXX holds the first and second month volatility futures (VIX Futures). By purchasing, you are effectively long the current month VIX futures and the next month VIX futures. To make money, the futures will need to go up, resulting in the value of the asset to increase. If the futures continue to decline, so will the price that VXX trades at. The inception date for VXX was 30 th Jan It has seen 5 reverse splits till September 2017, on these dates 9 th November 2010, 5 th October 2012, 8 th November 2013, 9 th August 2016 and 23 rd August Each of these were 4:1 reverse splits. Taking September 1, 2017 price of $46.17 and these 5 reverse splits, the inception price of VXX as of January 30, 2009 comes to $26, (as of September 4 th, 2017) So, if you would have purchased $26, worth of shares of VXX at inception, you would have lost $26, minus $46.17 = $26, or 99.83% of your investment. UVXY - ProShares Trust Ultra VIX Short-Term Futures ETF Stock UVXY is similar to VXX in that it holds the current and next month VIX futures contracts; however, it s goal is to provide two times leverage. It hopes to give double the daily move that the VIX futures are having. The leverage acts as a double-edged sword as it can provide massive upside moves or decay to $0 quicker. The inception date for UVXY was 3 rd October It has seen 8 reverse splits till September 2017 a 6:1 reverse split on 8 th

11 10 March 2012, a 10:1 split on 7 th September 2012, another 10:1 reverse split on 10 th June 2013, a 4:1 reverse split on 24 th January 2014, a 5:1 reverse split on 20 th May 2015, a 5:1 reverse split on 25 th July 2016, another 5:1 reverse split on 12 th January 2017 and the recent eighth 4:1 reverse split on 17 th July Taking September 1, 2017 price of $28.94 and these 8 reverse splits, the inception price of UVXY as of Oct 3, 2011 comes to $41,159,957. Yes, you read that correctly! Forty one million dollars has turned into $28.94 in six years. What does this show? That with time, UVXY is designed to go down in price. Also, UVXY is a 2x leveraged ETF. When we compare VXX and UVXY, while we notice that both lose value over time, UVXY being 2x leverage, goes down faster than VXX. TVIX - VelocityShares Daily 2x VIX ST ETN TVIX is similar to UVXY and is managed by Credit Suisse AG. Currently, options trading is not available for TVIX, whereas UVXY does have options. The inception date for TVIX was 29 th November It has seen 5 reverse splits till September 2017 a 10:1 reverse split on 21 st December 2012, a 10:1 split on 30 th August 2013, another 10:1 reverse split on 23 rd June 2015, a 25:1 reverse split on 9 th August 2016 and a 10:1 reverse split on 16 th March Taking September 1, 2017 price of $15.91 and these 5 reverse splits, the inception price of TVIX as of November 29, 2010 comes to $28,087,500. Yes, a little over twenty eight million dollars. Twenty eight million dollars has turned into $15.91 in seven years. What does this show? That TVIX, like UVXY is designed to go down. TVIX like UVXY is a 2x leveraged ETF. As compared to VXX, both TVIX and UVXY lost value faster. After knowing a little

12 11 about VXX, TVIX and UVXY, I am sure you would agree that they are designed in such a way that with the passage of time, their price only goes lower. SVXY - ProShares Short VIX Short-Term Futures ETF SVXY holds the front and second month VIX future contracts, however it shorts them. During low volatility times, these can gain value quickly from roll yield (explained in a later chapter). SVXY price goes up when UVXY, TVIX and VXX prices are going down. The inception date for SVXY was October 3 rd, Till September 2017, SVXY has split 3 times a 2 for 1 split on October 5 th 2012, a 2 to 1 split on January 24, 2014 and another 2 for 1 split on July 17, Taking September 1, 2017 price of $80.31 and these 3 splits, the inception price of SVXY as of Oct 3, 2011 comes to $5. In six years, a $5 investment in SVXY has become $ This turns out to be a 1,506% return on investment in 6 years, or 251% annualized return. Have you already started wondering why you didn t invest in SVXY way back in 2011? Note also that unlike VXX, UVXY and TVIX, SVXY has been rising year after year. Needless to mention, SVXY is also a VIX based ETF, and it does exactly the opposite of what VXX does.

13 12 XIV - VelocityShares Daily Inverse VIX Short-Term ETN XIV is similar to SVXY and it also holds VIX futures contracts short. XIV however does not have options available for trading where as we do have options for SVXY. The inception date for XIV was November 29th, Till September 2017, XIV has split once a 10 for 1 split on June 27, Taking September 1, 2017 price of $83.72 and the splits, the inception price of XIV as of 29 th November 2010 comes to $9.56. In seven years, a $9.56 investment has become $ This turns out to be a 775% return on investment in 7 years, or 110% annualized return. So, now we can safely assume that with time, while XIV and SVXY rise, VXX, UVXY and TVIX fall in value. If you are wondering why SVXY has returned so much more over a shorter time frame compared to XIV, the reason is this XIV started in 2010 and did very well till August However, during the period of August 2011 to October 2011, we saw backwardation which resulted in XIV price falling to a low of $4.98. After this, XIV indeed recovered. If you are wondering what backwardation is, don t worry. The term is explained in later chapters. VIX The Fear Gauge The pricing of the above ticker symbols is NOT dependent on VIX. Instead, they are dependent on VIX Futures. But what is VIX? The CBOE's Volatility Index, known by its ticker symbol VIX, is a popular measure of the implied volatility of S&P 500 index options, calculated and published by the Chicago Board Options Exchange (CBOE). It is referred to as the fear index or the fear gauge.

14 13 VIX was launched on January 1993 and more than 30 trading products have been created to let investors bet on its levels. VIX was created by Bob Whaley, a Vanderbilt University finance professor. Here is how BOB Whaley describes VIX to the reporter Graham Rapier (published on investing.com): "Technically speaking, it is the expected volatility of the S&P 500 over the next 30 days. But the way I explain it is the price of insurance. If you were to own a house on the North Carolina coast or Florida coast and you hear the news of this hurricane coming, would you be willing to pay more for insurance? And the answer to that is presumably so. In normal times, you may not be willing to pay as much. But when you know an event like that has a strong probability of occurring, what you'll do is pay more for insurance. What happens is people want to buy more insurance, and the insurers are willing to sell it, but not at the same price. What they'll do is escalate their price because they have to be hedged in terms of their exposure. So, during these times, like the hurricanes, people are willing to pay extremely more for insurance. The analogy is institutions or people may have a pension fund largely consisting of stocks, now what happens when they become frightened of a stock market crash? They can exit their position, but they can also buy index put options. Essentially those are the insurance policy. These put options provide you with insurance on your stock portfolio, so if the market dives, the value of these put options will go way up and you won't lose any money.

15 14 The reason VIX is called the investor fear gauge is simply because it's driven by the demand for S&P 500 index put options. If institutions become frightened by certain geopolitical risks, what they'll do is rush in and buy a bunch of index puts. When they buy those, the VIX level will go up because it's nothing more than a weighted average of the prices of those puts." VIX had an all time high value of on 20 November This reflects the high amounts of fear as the financial crisis unfolded. All-time lowest intraday VIX value was 8.84 on 26 th July As you would have guessed by now, a high VIX value signifies extreme fear in the financial markets which coincides with falling stock prices. Again, a low VIX value would signify little fear in the financial markets which coincides with rising stock prices. VIX Futures VIX futures are traded practically 24 x 7. At any given point of time, VIX futures are traded for that month and for each of the next 7 months. Once again, the pricing of VXX, UVXY, TVIX, SVXY and XIV is dependent on VIX futures and not VIX. In the next chapter, we will see how the VIX futures of the current month and the next month dictate the price of these 5 VIX related funds. Here is the disclosure once again: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting

16 15 or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. As an investor, you are fully responsible for any investment decision that you make.

17 16 Chapter 3 Overview of Pricing of Volatility ETFs/ETNs VIX Futures VIX futures are traded everyday except for Saturday s. When markets are open, participants can purchase VIX contracts for the current month or as far out as seven months. Since VIX futures are the backbone of our discussion, we need a way to name them. We will call the current month VIX futures M1 and the next month M2. The last contract, seven months from the current month will be M8. Each month s VIX futures expire on a Tuesday (but their settlement happens on Wednesday the next day), which falls roughly during the middle of the month. For 2017, the September VIX futures expire on September 19, October futures on October 17, November futures on November 14, and December futures on December 19. January 2018 futures expire on January 16, February 2018 futures on February 13, March 2018 futures on March 20 and April 2018 futures expire on April 17. If you want to see where VIX futures are at any point of time, the best place to visit is: Here you can see data such as current prices, the difference between contracts and the current value of the VIX index. One of the most important things we are interested in is the Contango, which is the difference between M1 and M2.

18 17 To explain further, let s take an example from vixcentral.com: For the above VIX Futures graph, we see that M1 = 13.31, M2 = and spot VIX = These are the values as of September 3, 2017 and M1 expiration is on September 19, As minutes, hours and days pass, we might see different values of VIX as well as different values of M1 and M2. But the main point to note is on the day M1 expires, it will be brought towards the VIX value. So, in our example, either M1 will fall from to on September 19. Or VIX will rise to on September 19 at the close. Usually the VIX value and M1 will meet in the middle on the day of the current month VIX futures expiration. High Level Detail - How M1 and M2 affects pricing of the Volatility based ETNs? To understand how the VIX futures impact the prices of the VIX based ETFs / ETPs, let us analyze the VIX Futures graph on September 3, 2017 (which is available on vixcentral.com).

19 18 M1 = M2 = M3 = M4 = M5 = M6 = M7 = M8 = Spot VIX = Note that on September 3, 2017, M1 is the current month VIX future (September 2017) and M2 is the next month VIX Futures (October 2017). VXX, UVXY, TVIX, SVXY and XIV all hold M1 and M2 futures. Everyday after the market closes, the companies who manage the ETPs, rotate the amount of M1 and M2 futures. This is done by buying and selling the futures minutes after the market close. The rebalancing is one of the larger causes of decay to UVXY and TVIX. Using VXX as an example, we can examine the rebalancing. VXX would sell M1 futures which are at and buy M2 futures which are at What do you think will happen to VXX price then? The VXX price will fall, since their business model is sell low (13.31) and buy high (14.25). In real terms, it is not as simple as this and we will come to the nitty gritty in a minute.

20 19 The point is VXX will lose value since it is selling M1 at a low price and buying M2 at a higher price. Same is true for UVXY and TVIX. But since they are 2x (2 times) leveraged, their price fall will be about double the price fall of VXX. SVXY and XIV do the opposite of what VXX does. For this particular day, SVXY and XIV will sell M2 (at 14.25) and buy M1 (at 13.31). Since they are selling high and buying low, SVXY & XIV will have a higher price at the end of the day when this rebalancing occurs at 4:15 PM EST. It is also important to note that when M1 or current month VIX futures expire (on that middle of the month Tuesday), then M3 becomes M2 and M2 becomes M1 the next day i.e. Wednesday. So, after September 19, 2017 (when the September VIX futures expire), on September 20, 2017, the current month VIX futures M1 will be October 2017 and the next month VIX futures will be November Contango Since M1 (13.31) is less than M2 (14.25), we can say that there is Contango. There is no universal way to calculate the Contango. Some calculate the Contango as (M2 M1) / M1. In

21 20 this example, the Contango comes to ( ) / = 7.06% Others calculate the Contango as (M2 M1) / M2. In that case, the Contango would be ( ) / = 6.6% To summarize, Contango is the situation where the VIX ETNs/ETFs have to deal with current month VIX futures being priced lesser than the upcoming month VIX Futures. At this stage, you can note that Contango is a price suppressant for VXX, UVXY & TVIX (and gives a price boost to SVXY & XIV). Backwardation Look at the above chart where the VIX future values are as follows: M1 = M2 = M3 = M4 = M5 = M6 = M7 = M8 = M9 = Here, since M1 (which is ) is more than M2 (which is ), we can say that there is Negative Contango or backwardation. In this example, the negative Contango or

22 21 Backwardation is (M2 M1) / M1 or ( ) / = - 33% Others might have calculated the Negative Contango or Backwardation as (M2 M1) / M2 or ( ) / = % To summarize, Negative Contango or Backwardation occurs when the VIX ETNs/ETFs have to deal with current month VIX futures being priced higher than the upcoming month VIX Futures. At this stage you can consider backwardation as a tail wind for VXX, UVXY and TVIX where their prices would rise. Also, backwardation would a headwind for SVXY and XIV and their prices would fall. VIX Futures Graph changes as VIX futures are traded Since VIX futures are traded practically 24 x 7, the values of M1 to M8 will also keep on changing. By just having a quick glance at the VIX futures graph (available at vixcentral.com), you would come to know if we have Contango or are in Backwardation. When looking from left to right, a rising slope of the VIX futures graph would suggest that we have Contango, and a falling slope would suggest that we are in backwardation. Based on our analysis of historical VIX futures, we can say that when we are in a bull market or a flat market, VIX futures will be in Contango (with VIX futures graph having an upward slope). On the other hand, if we were in a recession and a bear market (or when the stock market is in a severe correction), we would be in backwardation (with VIX futures graph having a

23 22 downward slope). Using this information, a savvy investor who trades in Volatility can define his plan of action. Conclusion The pricing of VIX based ETFs / ETNs is not based on spot VIX but VIX futures the current month VIX futures (M1) and the next month VIX Futures (M2). In general, it is safe to say that when there is Contango, it will help in price increase of XIV & SVXY and price drop of VXX, UVXY and TVIX. When backwardation occurs, it will help in price increase of UVXY, VXX, and TVIX and price drop of XIV & SVXY. Here is the disclosure once again: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. As an investor, you are fully responsible for any investment decision that you make.

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25 24 Chapter 4 How VIX Related ETFs/ETNs Are Priced? In this chapter, we will try and understand in a little more detail, how the volatility based ETFs / ETNs are priced. If you are not into analyzing things in detail, you can skip this Chapter. Below is the VIX futures graph on Tuesday, September 19, Note that September 19, 2017 is the last day of this cycle, which started on Wednesday August 16, On the market close on September 19, 2017, VXX would hold (1/24) or 4.17% of August VIX futures (M1 = ) and (23/24) or 95.83% of September VIX futures (M2 = ). Where does this number 24 come from? Well, the August 16, 2017 to September 19, 2017 period consists of 24 trading days. On the first day i.e. August 16, 20017, VXX will hold (24/24) or 100% of August VIX futures and 0% (0/24) of September VIX futures.

26 25 The next day, i.e. August , VXX will hold (23/24) or 95.84% of August VIX futures and (1/24) or 4.16% of September VIX futures. So, with every passing day, VXX is reducing the proportion of the current month VIX futures and increasing its proportion of the next month VIX futures. This in a nutshell is what is happening to VXX pricing. The fund that runs this ETF publishes its NAV (Net Asset value) every day in the evening after this M1, M2 re-balancing has happened. The Next Cycle Let us try and understand what happens in the new cycle that begins on September 20, 2017 and ends on Tuesday October 17, Note that here, we have only 20 trading days. Also, now the current month VIX futures (M1) is September and the next month VIX futures (M2) is October. Below is the VIX futures graph on Wednesday, September 20, 2017.

27 26 On Wednesday, September 20, 2017, VXX will hold (20/20) or 100% share of September VIX futures (M1 = ) and (0/20) or 0% of October VIX futures (M2 = ). From the VXX (ipath S&P 500 VIX Short-Term Futures ETN) website, we can find out that at the end of September 20, 2017, the NAV (net asset value) of VXX was $ Let us do a simple weighted average calculation. 100% of plus 0% of is equal to And weighted average of M1, M2 on September 20, 2017 is which equates to VXX price of $40.79 The next day, on September 21, 2017 at 4:15 PM EST, the VIX graph was as shown below. Note that M1 = and M2 = On September 21, 2017, VXX will hold (19/20) or 95% share of September VIX futures (M1 = ) and (1/20) or 5% of October VIX futures (M2 = ). Let us do a simple weighted average calculation now. [(19/20) x ] plus [(1/20) x ] comes to

28 27 [95% of ] plus [5% of ] which is plus which is From the previous day, we already know that the weighted average of M1, M2 on September 20, 2017 was which equated to VXX price of $ And now we know that on September 21, 2017 the weighted average of M1, M2 is Using simple ratios, we can find price of VXX on September 21, 2017 (VXX Price on September 21) / (VXX price on September 20) = (weighted average of M1, M2 on September 21, 2017) / (weighted average of M1, M2 on September 20, 2017) (VXX Price on September 21) / ($40.79) = / VXX Price on September 21 = ( / ) x $40.79 = $ If we go to VXX (ipath S&P 500 VIX Short-Term Futures ETN) website and look at their NAV on September 21, 2017, we will see that their NAV is $40.96 against our calculated price of $ So, what is happening here is every day, the company that runs this fund is taking a small percentage as their fees. We can verify this in another way. (weighted average of M1, M2 on September 21, 2017) / (weighted average of M1, M2 on September 20, 2017) = ( / ) = (Actual VXX Price September 21 / Actual VXX price September 20) = $40.96 / $40.79 =

29 28 Pricing for UVXY, TVIX, SVXY and XIV The pricing of UVXY, TVIX, SVXY and XIV is also similar. Let us take UVXY as an example. From Proshares Ultra VIX Short-Term ETF UVXY website, we can get the NAV for September 20 as $ Using simple ratios, we can find price of UVXY on September 21, 2017 as follows: (UVXY Price on September 21) / (UVXY price on September 20) = (weighted average of M1, M2 on September 21, 2017) / (weighted average of M1, M2 on September 20, 2017) (UVXY Price on September 21) / ($ ) = / UVXY Price on September 21 = ( / ) x $ = $ If we go to Proshares Ultra VIX Short-Term ETF UVXY website and look at their NAV on September 21, 2017, we will see that their NAV is $ against our calculated price of $ Notice that here, our NAV comes slightly higher than their NAV. We can call this noise and we don t have to worry too much about this minor difference. General Rules on M1 and M2 affecting price of VXX, TVIX and UVXY Based on our understanding of how the current month and next month VIX futures affect pricing of these Volatility based ETFs / ETNs, we can formulate the below rules, when VIX futures have a rising slope and we are in Contango: If both M1 and M2 fall as compared to previous day s M1 and M2, VXX price will fall. This means TVIX and

30 29 UVXY prices will also fall and SVXY and XIV s price will rise. If both M1 and M2 rise as compared to previous day M1 and M2, VXX price will rise. This means TVIX and UVXY prices will also rise and SVXY and XIV s price will fall. If M1 falls as compared to previous day s M1 and M2 remains the same as previous day s M2, then VXX price will fall. This means TVIX and UVXY s price will also fall and SVXY and XIV s price will rise. If M1 rises as compared to previous day s M1 and M2 remains the same as previous day s M2, then VXX price will rise. This means TVIX and UVXY price will also rise and SVXY and XIV price will fall. If M1 is the same as previous day s M1 but M2 falls as compared to previous day s M2, then VXX price will fall. This means TVIX and UVXY s price will also fall and SVXY and XIV s price will rise. If M1 is the same as previous day s M1 but M2 rises as compared to previous day s M2, then VXX price will rise. This means TVIX and UVXY s price will also rise and SVXY and XIV s price will fall. If M1 falls as compared to previous day s M1 and M2 rises as compared to previous day M2, then the VXX price will depend on which day of the cycle we are and the weighted average calculation can let us know what the final price is. In the earlier chapter, we made a statement that when VIX futures have a rising slope, it means that we are in Contango and therefore VXX s price will fall. That statement is not actually true because as per the above rules, we could have Contango, but a rise in M1 or M2 could result in a price rise of VXX.

31 30 Disclosure: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. As an investor, you are fully responsible for any investment decision that you make.

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33 32 Chapter 5 The Strategy There is no doubt that if you are trading volatility, you need to have a well thought out strategy that can achieve these objectives: a) Deliver maximum returns b) Manage risk, especially during times of high volatility The Strategy Here is our strategy: 50% of the portfolio stays in cash to cushion inevitable increases in the VIX futures Use 30% of the portfolio to trade (on a daily or weekly basis) in volatility ETFs / ETNs to generate daily / weekly profits which increase your portfolio value gradually. In the short term, this strategy aims to profit by being long SVXY & XIV and being short on VXX, TVIX and UVXY. Your aim is to exploit the daily (or weekly swings) to generate consistent profits. This can also be done using options. Use 20% of portfolio value to hold short volatility based products long term. Also, with every 20% fall in price of the short volatility products like UVXY, TVIX, VXX, add additional shares short. One will need to add short shares to maintain a 20% value.

34 33 50% CASH Component Keeping 50% of your portfolio in cash is the key to this strategy. If you observe the price movement of volatility based products, you will notice that a daily price swing of 1% is not uncommon. Also, 2x leveraged instruments like UVXY and TVIX periodically make moves which are in the range of 5% to 10% (either to the downside or to the upside). In rare experiences, UVXY and TVIX have risen as much as 25% in a day. Keeping 50% cash in your portfolio allows you to ride such storms and prevents margin calls. Let us try and understand this with an example. Imagine, you have an account of $50,000 which is fully cash and you have a margin account. Most brokerages will allow you the benefits of margin, which in turn would mean that your account would have a daily buying power which after including the margin would allow you to trade up to $100,000. The moment you buy (or sell) a stock, the margin balance (and the withdrawable cash balance) gets reduced. Investors and traders make the classic mistake of overtrading and using too much margin. Overtrading results in churning trading fees, which cut into profits. Using too much margin can also result in large losses. This is especially true when using options. Be extra cautious if you are using borrowed money when trading. Let us understand this with an example. Assume that you start a brokerage account by depositing $50,000. If you are trading volatility, you are making sure that all times, you are keeping 50% of $50,000 i.e. $25,000 as cash. This also means that you are not utilizing the margin money at all. The 50% cash in your account helps you ride the waves of volatility spikes.

35 34 30% Swing Trade Component You use 30% of your portfolio to day trade volatility products. In our example, you use 30% of $50,000 which is $15,000 for this purpose. Below is a list of the numerous ways you can profit from swing trades. Subsequent chapters will explain each of the below in detail. Long XIV or SVXY, buy low and sell high to make swing trade profits Short VXX, UVXY, or TVIX, where you use regular market hours as well as pre-market and after hours to first sell short these instruments at their daily highs and then buy to cover them at their daily lows. On days when you observe huge spikes in UVXY, TVIX & VXX, layer into a short position. If TVIX starts trading at $17 and starts rising, you would first start with a small short at $17.85 (or a 5% price increase) with a hope that you can buy to cover at $17 or $16.75 during the day. But unfortunately, it is not your day and you see TVIX continuing to rise. You DO NOT short at 25 cents interval. You carefully layer your shorts by having orders in place to short at a 10% price increase ($18.70) and then at a 15% price increase ($19.55) and finally at a 25% price increase ($21.25). After the volatility peak is reached, you ride the train down and cover the shorted quantities at a profit as the price goes down. Buy SVXY weekly or monthly deep in the money calls when SVXY is at daily lows and selling the calls for a profit during the same day, the next day, or the next week. Selling quickly decreases time decay that occurs when buying options. Note that if SVXY is trading at $80, a $78 strike call (or a $76 strike call) is called a

36 35 deep in the money call. Also note that XIV does not have options. Buy long dated deep in the money puts of VXX and UVXY when these instruments are at daily highs and sell them for profit the same day, the next day or the next week. Note that, if VXX is trading at $45 on September 9, 2017, a long dated deep in the money put could be December 15, 2017 expiry with a strike price of $56. While options are available for VXX and UVXY, TVIX does not have options. Sell ATM (At the money) or OTM (Out of money) naked calls for UVXY and VXX at least 2 months out. You close the calls (i.e. buy them back) when you realize profit. Most brokerages will allow selling covered calls meaning you own shares and then sell a call (called covered call) based on that holding. Selling covered calls against UVXY and VXX is not recommended. Instead, sell naked calls when the implied volatility is high and capture profits when calm returns (volatility has mean reverted). Note that selling naked options brings unlimited risk and will use considerable buying power depending on the strike price and your broker. Selling UVXY/VXX naked calls is quite profitable, but you need to manage risk as the values can fluctuate. For UVXY or VXX, sell an ATM (at the money) call and a put 30 to 45 days out. This is known as a straddle. Straddles are known as a neutral strategy as they are not betting on any price direction. Overall, the gains in the call would offset the losses in the puts or vice versa. However, you are capturing theta decay which comes from the call and put both losing value as they age. Subsequent chapters deal with this component in further detail

37 36 20% Core Short Component Holding a 20% short position (for a long-term period of 1 year or more) using a mix of TVIX and UVXY is what brings in the most profits. We had mentioned earlier that in 6 years, UVXY came down from $41 million dollars to $28.94 and VXX came down from $26, to $46.17 in eight years. The 20% short trade component looks to capture the full decline of VIX ETPs over longer periods of time. Ideally, the first initial short position would be done on a day when TVIX or UVXY has a large price increase. The position size would be 20% of the total portfolio (excluding brokerage fees & commissions). This will be a core short position. Considering past historical data, it would be safe to assume that TVIX will lose 20% of its value anywhere from 30 to 45 days. Assuming you initiated the core short in TVIX when it was trading at $17, you can expect it to fall to $13.60 (20% decline) in 30 to 45 days. When this happens, you are not rushing to buy to cover. Note that you have freed some capital. In the theoretical case that you would buy to cover 100 shares at $13.60 amounting to $1,360, you would have made a profit of $1,700 minus $1,360 or $340. Now, when TVIX loses its value by 20% (i.e. from $17 to $13.6), you add additional shares short ($340/$13.6 which comes to 25 additional TVIX shorts) to have the portfolio value back to 20%. You continue this strategy with every 20% fall in TVIX s price. It is hoped that the 30% of short term trading capital will help grow the overall portfolio in addition to the fall of TVIX and UVXY. This will help to build a bigger short holding. Thus, after you initiated your core shorts, over the next 12 to 14 months, you will be making 12 more transactions of additional shorts. During this journey, you will see at least 2 reverse splits

38 37 of TVIX. If you want, you can continue this activity of having additional shorts up to perpetuity (which will reduce your Federal Income tax bill as well). Assuming you want to cash out after say 24 months, you can buy to cover then, to realize handsome gains. You are making use of time and the power of compounding to make attractive profits. The above strategy gives the example of TVIX. You could implement this strategy for UVXY as well. Also, VXX could be used but the ROI will be smaller due to the fact that VXX only has 1x leverage. It is important to note that with this strategy, while the price of TVIX and UVXY is decreasing, your short quantities are increasing. This would mean that while your account is growing, you would need to pay close attention to your cash balance in your account. Over the long periods of 12 to 14 months, the 30% Swing Trade Component would be adding consisting profits to your account and help you maintain the core and additional shorts. Conclusion By having a mix of 50% cash, 30% short volatility swing trade and 20% of core shorts held long term, you can realize very attractive return on investment. You require careful planning and a strict discipline to succeed, when you are investing in volatility. In the subsequent chapters, we will be detailing each of these trade ideas in sufficient detail.

39 38 Disclosure: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. As an investor, you are fully responsible for any investment decision that you make.

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41 40 Chapter 6 Why Going Long Volatility Is Usually Unwise Before discussing the short volatility strategy in detail, let s discuss why being long volatility is usually a bad idea when we are NOT in a recession or a bear market. Being long volatility means you are buying volatility products like UVXY, VXX or TVIX or shorting SVXY and XIV. Are we in a Recession? It is important to understand the stage of the economic cycle we are in. Are people being employed or unemployed in large numbers? Is the consumer confidence positive? Are jobless claims lower? Is the housing industry thriving with rising prices? You do not have to be an economist to figure out if we are in a recession or not. As long as publicly traded companies have good earnings, the stock market index will continue to push higher and we would not see a recession or a bear market. When we are not in a recession or a bear market, the VIX futures graph will have a rising slope as shown in the figure on the next page.

42 41 Notice that M1, the current month VIX futures (which is ) is lower than M2, the second month VIX futures (14.325). It is expected that the price of instruments like VXX, TVIX and UVXY would fall month after month as they would be selling M1 at a lower price and buying M2 at a higher price. Below is the chart depicting VIX futures in October 2008, when we were in a recession. During the recession, we will see the VIX futures chart showing a downward slope looking from left to right. Notice that M1, the current month VIX futures (which is ) is higher than M2, the second month VIX futures (42.78). It is

43 42 expected that the price of instruments like VXX, TVIX and UVXY would rise month after month as they would be selling M1 at a higher price and buying M2 at a lower price. Volatility Trading strategies during a recession & a bear market is discussed in Chapter 16. According to the Bureau of Labor Statistics, the last recession began in December 2007 and ended in June While UVXY, TVIX, XIV and SVXY were introduced much later, VXX was introduced on 30 th January Thus, between February 2009 and June 2009, there was an opportunity to trade VXX when we were coming out of recession during this period. Note that officially, we were completely out of recession in July Here are the VXX prices on some dates during Feb 2009 to June Date VXX Closing Price February 2, 2009 $26, February 20, 2009 $30, March 13, 2009 $26, March 30, 2009 $29, April 15, 2009 $25, May 15, 2009 $21, June 15, 2009 $19, July 15, 2009 $17, August 13, 2009 $14, As you can see from the above table, it is reasonable to expect VXX price to rise during a recession as was the case in

44 43 February and March Note that, while the recession ended in June 2009, as per Bureau of Labor Statistics, the stock market and the VIX futures were already out of recession and the bear market mode after May 2009 and we see the gradual VXX price fall in June, July, and August If all past bull and bear market duration is analyzed, you would notice that generally bull markets happen for long periods of time (anywhere from 7-to-10 years or even more). On the other hand, bear markets which are a result of recession, are for short durations one to one and a half years. To conclude, there is a good justification for going long volatility only during a bear market and recession. One might consider a short term long trade after an event has happened that changes market fundamentals such as oil going to all time lows. While these events are rare, they do cause uncertainty. It is important to understand there is less risk waiting for the increase in volatility and shorting VXX, UVXY and TVIX than waiting for an event and going long those tickers. A Crystal Ball Will Help Time The Market It is very difficult to time the market (on an hourly, daily or weekly basis) and decide when to go long volatility. As I always say, you need a crystal ball that can show you when to go long volatility. Unfortunately, no one has this crystal ball. However, once the volatility has risen (which you can easily observe and monitor), it has to fall since volatility mean reverts. It therefore makes sense to short volatility when it has peaked and wait for the calm to return for covering. Or buy XIV & SVXY when volatility is at its peak as you would get them cheaper and sell them when the calm returns and volatility falls.

45 44 I Heard Going Long Can Give Great Daily Returns A majority of retail traders who tend to go long volatility do so, solely with the aim of securing a fantastic 30% return from holding for a couple days or less. Sometimes, they get lucky more than once. But if they continue to try their luck, they end up losing or even worse holding onto shares for shorts to borrow. I would encourage you to visit stocktwits.com, a very popular investment social media site. Follow the discussion threads for these volatility tickers VIX, VXX, UVXY, TVIX, SVXY and XIV. The discussion board of UVXY has possibly the highest number of posts. With a little analysis over time, you can see that users who are bullish or long volatility come and go. They leave the site, once they have suffered losses. On the other hand, volatility shorts are few, they appear to have done their homework and are there for a long period of time. Having said this, we would not say that volatility shorts always make money. They indeed would have suffered huge losses or drawdowns during August 2015, when there was a huge spike in VXX, TVIX and UVXY and a huge drop in SVXY and XIV. As a volatility short, you will lose money only when you do not have a plan with discipline or when you do not have proper risk management in place. We have covered risk management for volatility short strategy in Chapter 15. Going long UVXY is like playing slot machines at a casino. If you can afford to keep playing, it is possible to make money. If you keep playing, the casino (the people on the short side) will take your money. Shorting Volatility Is Crowded I have seen many folks comment (after reading articles in the financial media), that they are long volatility because everybody

46 45 and their grandma is short volatility. The trouble with this idea is that UVXY does not necessarily see big fluctuations day-to-day due to supply and demand. It would require all the shorts to cover at once, and then the authorized participants who manage the tickers day to day would short them down to fair value. The only way UVXY or other tickers could experience a short squeeze is if people shorting the VIX futures all cover. While this is possible, many people short volatility through options, being long SVXY and XIV and shorting UVXY and TVIX. If you want your account to turn to zero, you can read publications like zerohedge.com on an hourly or daily basis and take their advice. Such publications thrive on fear mongering, war mongering and sensationalism. For multiple years, they have had screaming headlines of a S&P 500 crash which has not happened. Also, if you visit social media investment sites like stocktwits.com and follow the discussion thread under UVXY, you will see many posts from volatility bulls exaggerating negative news. Analyze the facts behind such posts, and don t get swayed by their opinions as they have been pulled from thin air anyway. While established financial media outlets like CNBC and Bloomberg (and their online versions) are better in terms of their content, they still carry articles which have opinions. At times, it appears they are being manipulative and such stories are being planted just to scare the retail investor to take a wrong investment decision. Some articles would claim that a certain financial analyst is forecasting a 20% S&P 500 correction or another financial analyst is forecasting a 5% S&P rise. These financial analysts are only putting forward their opinion and there is no guarantee that it could turn out to be true. If you are an investor (especially trading in volatility), read and absorb facts (like the unemployment numbers, GDP growth rates and Consumer Confidence numbers), not opinions.

47 46 Technical Analysis Shows UVXY Will Rise The volatility based ETFs/ETNs are not stocks and technical analysis does not apply to them. They purely work on the values of current month VIX futures (M1) and next month VIX futures (M2). Having said that, I have noticed two things. If the price of these volatility tickers touch or is higher than the upper Bollinger band, it is a very safe play to short VXX, TVIX & UVXY (and buy SVXY & XIV). On the other hand, while in many instances when the price of VXX, TVIX & UVXY touches the lower Bollinger band, their prices could rise, this is not a guarantee. It could very well happen that VXX, TVIX & UVXY prices keep falling, thereby stretching the lower Bollinger band ever further lower. A Friend Gave Me a Tip To Go Long It is your hard-earned money. So, do your due diligence before following anyone s suggestions or views, including this book. It Is Time To Go Long Due To Terrorism And Worldly Uncertainty There is no doubt that there will be periodic threats due to natural disasters and geo political situations, which will induce volatility in the stock market. However, we as a human population get used to a situation, if it starts happening multiple times. First time when there was a terror attack, stock markets plunged. But in later days, acts of terrorism increased and these acts no longer result in stock market crashes. Why? Because we

48 47 get used to such situations and have developed a tendency to move on. The same is true with natural calamities like Tsunami, floods, hurricanes and earthquakes. At best, such natural calamities introduce stock market volatility for a day or two and then normalcy returns. In fact, economist consider that such natural calamities result in increased economic activity because of rebuilding efforts, which invariably results in rise in the stock market in the long run. Threats of war between two or more countries have little impact. There have been many war threats and actual wars between countries in the past. And if the USA has been involved in any war, the result has always been a rise in the stock market index because of patriotism and increased activity in the defense sector spending. I am bullish volatility now. I will turn bearish soon. Why? Did you purchase a crystal ball that works accurately? I would rather be long volatility as I fear UVXY can spike four times in price (like in August 2015) and my brokerage account will be wiped out if I am short volatility and this happens. This is a very good point. On August 3, 2015, the closing price of UVXY was $2,525. It indeed spiked to $8,754 on September 1, This was a 3.46 times spike in a matter of one month (and not a 4 times spike). Still, we have to agree that this spike was

49 48 huge. But by October 19, 2015, UVXY had recovered almost all its losses and was trading at $2,758. UVXY was launched in October Taking into account all its reverse splits, UVXY s price at the time of its launch was $41.15 million dollars. And on August 3, 2015, it had fallen all the way to $2,525. If you had been short UVXY right from the day of its inception, you would have made enough money to not care about the 3.46 times spike from $2,525 on August 3, 2015 to $8,754 on September 1, 2015 and you would have exploited the volatility spike by shorting more with the extra cash you earned. On January 2, 2015, UVXY was trading at $13,915. If you had entered the trade of shorting UVXY on January 2, 2015, you could still have managed, because the September 1, 2015 spike price of $8,754 was still lesser than the Jan 2, 2015 price of $13,915. The bottom line is, if you had close to 80% cash (50% cash and 30% swing trade component which can be converted to cash by a couple of button clicks), and only 20% invested in volatility shorts, you would have been able to manage the situation. Let us take a look at some key dates From July 2015 to October 2015, along with VIX futures curve to understand if we can predict such huge spikes. July 6, 2015, UVXY closing price was $4,470 Rising VIX futures graph. VIX monthly futures are in Contango.

50 49 August 3, 2015, UVXY closing price was $2,525 Rising VIX futures graph. VIX monthly futures are in Contango. August 20, 2015, UVXY closing price was $3,136 First signs of danger when current month VIX futures M1 = next month VIX futures M2 August 21, 2015, UVXY closing price was $4,191 Falling VIX Futures graph (especially M1 and M2). VIX futures in backwardation.

51 50 September 1, 2015, UVXY closing price was $8,754 Falling VIX Futures graph. VIX futures in backwardation. October 5, 2015, UVXY closing price was $4,353 M2 onwards, we have a rising VIX futures. October 8, 2015, UVXY closing price was $3,820 VIX futures graph has fully recovered. VIX futures in Contango

52 51 From the above analysis, we can conclude that When VIX futures are in Backwardation, it would give you additional opportunity to make use of the increased volatility (and the UVXY price spike) to short more and profit more. But the key here is to have sufficient liquidity (cash balance) to handle the situation. You would need 80% of portfolio as cash. This would require turning the 30% of cash used for short term trading into a cash position. By just keeping an eye on the VIX futures graph on a daily basis, we can make an overall assessment if UVXY price is going to drop or rise in the near term (coming month) to intermediate term (next three to six months). It would be prudent to have risk management in place at all times & especially when we see the first signs of backwardation. A conservative play would be to completely close all shorts and return the portfolio to 100% cash at the first available signs of backwardation. Once the normalcy is restored and we start seeing VIX futures graph having a rising slope, we can resume our short volatility positions. I am long Volatility since I have investment in various stocks and I want to hedge my portfolio by being long VXX, UVXY and TVIX Well, UVXY, TVIX and VXX are not the recommended instruments to hedge. If at all you want to hedge buying put options on the SPY should work. Investors also buy gold as a hedge.

53 52 Conclusion If you do not understand volatility based ETFs / ETNs, stay away from them. If you want to invest or trade in them, first make an attempt to understand how they work. In normal times (i.e. when we are not in recession or a bear market), being long these volatility products is a very poor investment decision since these instruments are designed to go down in price with time. Here is what the prospectus of UVXY says: Designed for knowledgeable investors who seek to profit from increases in the expected volatility of the S&P 500, as measured by the prices of VIX Futures contracts Intended for short term use: Investors should actively manage and monitor their investments, as frequently as daily. If at all you feel like going long UVXY, TVIX & VXX during the trading day, it is wise to close the position at the end of the day either for a profit or a loss based on the clear warning specified in the prospectus. Disclosure: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and escribed were or will be profitable. As an investor, you are fully responsible for any investment decision that you make.

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55 54 Chapter 7 30% Portfolio Swing Trade Being Long XIV & SVXY This chapter deals with the aspects of doing multiple trades being long XIV and SVXY during the day or week to scalp small but regular profits. Brokerage Commission and Fees If you are an active trader, you need good brokerage rates. Call your brokerage and negotiate fees. Tell them that you propose to do a large volume of transactions per week and you need a better pricing. You can tell them that you are planning to switch to a rival brokerage firm because they are giving you a better deal. I bet, your existing brokerage will reduce the commission and fees. I got a very good rate from Scottrade where I am charged $3.00 per order when buying or selling shares. So, whether I am buying 100 SVXY or 500 XIV, the additional amount that I would be charged as fees is only $3.00. Note that when you sell these shares, they would charge you this commission of $3.00 once again. For options, Scott Trade used to charge me $6.95 per order plus $0.70 per contract. I was able to negotiate and get a 50% discount. We will discuss options in later chapters. I have another brokerage account with For options, they charge $1.00 per contract when you open the contract. They have zero commission to close the option. If you are trading stocks, they charge $5 per order (unlimited shares)

56 55 when you start the trade (buy or sell short) and they have zero cost when you close the trade (sell stock or buy to cover). If your brokerage doesn t give you a good price, you should seriously move your account to some other brokerage. Buying and selling XIV and/or SVXY One advantage of trading shares instead of options is you can make use of pre-market and after-hours trading. Make sure that your brokerage allows you to enter trades before the market opens and after the market closes. This is particularly useful as many times, you will get attractive pricing (either for buying or for selling). Daily Price Swings in XIV and SVXY The below table shows some random dates and the opening price, daily high and low and closing price. Note that the difference between daily high and low is attractive to make decent profits, first buying XIV and/or SVXY low and then selling them high, day after day after day. Date Ticker Opening Price $ Daily High $ Daily Low $ Closing Price $ February 14, 2017 April 6, 2017 July 12, 2017 SVXY SVXY SVXY

57 56 February 14, 2017 April 6, 2017 July 12, 2017 XIV XIV XIV As you can see, SVXY and XIV saw a $2 to $3 price swing each trading day. You can swing trade by buying at daily lows and selling at daily highs to make profits. But how do you find what price is the daily low and the daily high. You can use charts or tools provided by your brokerage. I use the Scottrade Elite which has a good pictorial representation of the ETF/ETN price movement. As seen in the below screenshot, you buy when SVXY and XIV are fully red.

58 57 And you sell SVXY or XIV when they are fully green. You might not get an opportunity to enter in such trades every day. If you do not get such an opportunity, that is fine, keep waiting. There is no need to start a trade if you don t get the opportunity. Now, the key question is how much trading profit to aim from such swing trades? Ideally, you should see if you can buy at daily lows and sell at daily highs. This might not be easy as it sounds. In such a case, if you see a reasonable profit, you should exit the swing trade. Let s take an example. You bought 100 SVXY for $75.23 by spending $7,523. During the day, you see the SVXY priced at $75.77 and if you sell the 100 shares, you will get $7,577 and thus a $7,577 minus $7,523 = $54 profit. Note that a $54 profit on a $7,523 investment, results in an annual ROI of %. Since there are 5 days a week and 52 weeks in a year, if you even did one such swing trade each day, your ROI would be (54/7,523) x 5 x 52 x 100 % = % Using Limit prices to trade XIV and SVXY Instead of using market prices to buy XIV or SVXY, you can input your order, say for 100 shares at a specific price of your choosing. Limit prices will help you get fills for the price you want. The alternative is a market order. You are essentially

59 58 sending a blank check to the exchange and asking them to write a price. Market orders often end up costing you more and this adds up over time. Disclosure: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. As an investor, you are fully responsible for any investment decision that you make.

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61 60 Chapter 8 30% Portfolio Swing Trade Shorting UVXY, TVIX, VXX This chapter deals with the aspects of doing multiple trades being short VXX, UVXY and TVIX during the day or week to scalp small but regular profits. Shorting VXX, UVXY and TVIX As you would know by now, UVXY and TVIX are leveraged (2x) and hence their price movement during the trading day is double that of VXX. So, if you are shorting VXX you will likely make less money than shorting UVXY. Consider shorting all three tickers. The idea of this 30% Portfolio swing trade is you short these Volatility tickers at their daily highs and cover them at their daily lows for profits. You enter your sell short order for a certain number of VXX, UVXY or TVIX shares at a price that you wish by specifying the limit price. Once the limit price is reached, your order will be automatically fulfilled. The advantage of trading shares instead of options is you can make use of pre-market and after-hours trading. Make sure that your brokerage allows you to enter trades before the market opens and after the market closes. This is particularly useful as many a times, you will get attractive pricing (either for shorting or covering) in the pre-market or after-hours.

62 61 Process of shorting VXX, UVXY and TVIX UVXY, TVIX and VXX have huge daily price swings. On any given day, a 5% swing in the price of UVXY and 2.5% swing in the price of VXX is not uncommon. The idea would be to enter the order of short when you make an assessment that these volatility tickers have reached their daily highs. You wait for the prices to fall to their daily lows where you buy to cover the shares already shorted. There are many different ways to find good entry points for shorting. For example, one might use a chart and look for a spike intraday while someone else might use an indicator like relative strength. We enjoy using Scottrade Elite s High/Low indicator. When the bar for UVXY, TVIX or VXX is green/light blue, we will enter a short position. When the bar is red as seen in the picture below, that is a good time to cover.

63 62 It is important to be patient when entering and exiting positions. The market may not provide good opportunities every day and there is no need to force trades. It may also happen that you short VXX, UVXY & TVIX and their price rises during the day and you are unable to cover them at a profit. Let s say you short 100 UVXY at a price of $32. Unfortunately, you see the price rising over the next couple of days and the price is now approximately 10% higher at $35. You short another 100 shares at this price. If UVXY rises another 10% to $38, you short another 100 shares at this price. Remember that in 6 years, UVXY has fallen from 41 million dollars to around $28 (at the time of writing this book). If the market is still healthy or if the VIX futures has a rising upward slope, decay will lower UVXY s price as time goes by. Since this is the 30% Swing Trade component of your portfolio, your aim would be to cover these 300 shares at a profit and free up capital and add the profit to your cash balance. Now, the key question is how much trading profit should you aim for such swing trades? Ideally, you should see if you can short at daily highs and cover at daily lows. This might not be easy as it sounds. In such a case, if you see a reasonable profit, you should exit the swing trade. Let s take an example. You shorted 100 UVXY for $32 by spending $3,200. During the day, you see the UVXY priced at $31.50 and if you cover the 100 shares at this price, your profit will be $3,200 minus $3,150 = $50 profit. So you made a profit of $50 on an investment of $3,200. This comes to a ROI per day of (50/3,200)x100 = %. If you are successful in one such trade a day, then with 5 trading days a week and 52 weeks a year, your annualized ROI would come to x 5 x 52 = %

64 63 Using Limit prices to trade VXX, TVIX and UVXY Instead of using market prices to short VXX, UVXY & TVIX, you can input your order, say sell short 100 shares of UVXY at a specific price that you have mind. Since these tickers are volatile, you might be surprised how many times your orders are fulfilled. Take a scenario, where you see UVXY price at $32 and slowly rising. You may be able to put a limit order for shorting at a price of $32.50 and note that it gets filled. Layering your shorts If you see the price of VXX, UVXY & TVIX rising during the day, don t make the mistake of shorting them at 25 cent price difference. As explained earlier, layer in your shorts, making additional shorts for every 10% rise. Share Availability to Short The biggest constraint to shorting is finding shares to borrow. If you suspect you might get a spike in volatility, on days when UVXY or TVIX is not available, VXX often is available for shorting. We have several tips for getting shares to short. The first tip is, to enter multiple trades in the pre-market hours (early in the morning, 2 to 3 hours before the market opens). You enter orders to short UVXY or TVIX at different prices much higher than the current price. You will immediately see that the status of the order is pending approval, as shown in the screen shot on the next page.

65 64 Once you enter your short orders, your brokerage will try to find shares for you to short for that day. Once they are able to find the required shares to short, your order status will change from pending approval to open. During the day, you can modify the price accordingly. Note that the quantity of shares is available to short for the trading day. If the market closes and the limit prices are not hit, your short order will not get filled. If your short orders are filled, you can buy to cover the same day or the next day to close the position. Calling your brokerage with an additional request for Shorting UVXY & TVIX If you are unable to short shares during the day or not successful in reserving the shares to short, it would be a good idea to make a phone call to your brokerage and talk to them. You can make a request for shares to short. Your brokerage will reach out to see if they can borrow shares for you to short, from other investors who are long UVXY & TVIX. Note that if you get shares to short using this option, it might result in an additional short fee.

66 65 Margin for shorting When you place your order to short shares (and subsequently when the order is fulfilled), your margin maintenance gets impacted. Typically, each brokerage will have their own short selling margin requirements. The below screen shot shows the margin requirements needed by Scottrade. If you are shorting UVXY with Scottrade and if the price is above $14.30, you will need to maintain a 35% cash position to hold short. Also note that the margin requirement gets much higher for shares priced between $5 and $14.29.

67 66 Borrowing fees for shares shorted Your brokerage will also charge you a short fee, which is a fee you pay for shorting overnight. This fee may change frequently and is not necessarily fixed. It is important to check with your broker to see how the fee will impact overall profits. Note that the short fee is negligible as compared to the possible profits you would make when you short the volatility tickers like VXX, UVXY and TVIX. Brokerage may call shares back We have heard stories of traders shorting these ETFs/ETNs, and the brokerage called the shares back. This means that the brokerage takes control of the position and buys back the shares to close the position without giving the trader the option to hold the short longer. The chances of this happening are extremely low, but it is a risk of being short. Some brokers will call back shares when the person you are borrowing the shares from, sells their shares. Other times the broker will force the buy to cover if they messed up and over supplied shorts. Shorting shares by selling deep in the money naked calls An alternative way to get shares to short is by selling deep in the money naked calls for UVXY and waiting for the assignment of the option. Let us assume that UVXY is trading at $32. You go ahead and sell 1 naked call for strike price of $26 which are expiring the current Friday. You would get some call premium credited to your account. If UVXY does not reach $26

68 67 by end of Friday, your option will get assigned meaning your brokerage will deduct money from your account and your 1 naked call selling will be converted to 100 shares short at a price of $26. Shorting shares by buying deep in the money weekly puts An alternative way to get shares to short is by buying deep in the money weekly puts and waiting for the assignment of the option. Let us assume that UVXY is trading at $32. You go ahead and buy 1 put for strike price of $36 which are expiring the current Friday. If UVXY does not reach $36 by end of Friday, your option will get assigned meaning your brokerage will deduct money from your account and your 1 put buying will be converted to 100 shares short. Also, your brokerage will deduct additional amount for this short. Disclosure: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. As an investor, you are fully responsible for any investment decision that you make.

69 68 Chapter 9 30% Portfolio Swing Trade SVXY Call Options This chapter deals with trading SVXY calls to make regular profits. Note that XIV & SVXY are similar products; however, there are no options for XIV. SVXY does have options, but the spread between the bid price and the ask price is usually wide. I typically make use of the wide spread to my advantage. What are Calls in Options? If you are new to trading or options, you might be wondering, what are options? An option is common form of a derivative. It's a contract, or a provision of a contract, that gives the option holder the right, but not the obligation to perform a specified transaction with the option issuer or option seller. Call options provide the holder the right (but not the obligation) to purchase an underlying asset at a specified price (the strike price), for a certain period of time. If the stock fails to meet the strike price before the expiration date, the option expires and becomes worthless. Buying calls is a bullish position similar to going long stock. One contract equals 100 shares of stock. Put options give the holder the right to sell an underlying asset at a specified price (the strike price). The seller or writer of the put option is obligated to buy the stock at the strike price. If you are bearish on a stock, you buy puts.

70 69 Since we will be focusing our attention on calls, let us understand what strike price, expiry date, bid price and ask price means. Let us assume SVXY is trading at $85. You will be able to buy SVXY call options for various prices of the underlying security at this price or above and below it (for example $90 or $85) and this price of the underlying is called the strike price. The option with a strike that is the same as the current trading price is called an at the money option. Options for prices like $84, $83, $80 or $70, which are lower than the current price of $85 are called deep in the money options. Options for prices like $86, $87, $90 or 100$, which are higher than the current price of $85 are called outside the money options. Traders have a vast selection of expirations to choose from. These days, weekly options, monthly options and long-dated options exist for SVXY. The more time for expiration, the more the option will cost. After buying an option, it will decay with time. The closer an option is to expiring, the quicker it will decay. Just like stock, options have a bid-ask spread. Options are different in the sense that they sometimes have a one-dollar wide or greater spread. Using limit orders to buy off the bid price or in the middle of the spread is useful in reducing slippage. At this stage, this information is enough for us to proceed forward and let us try to understand how to trade in SVXY options to achieve daily / weekly profits.

71 70 Buying Off the Bid and Selling on The Ask Let us assume you are on September 11, 2017 and the plan is to buy weekly calls. When we say weekly calls, we mean the calls that expire this Friday, September 15, If SVXY is trading at $80 on September 11, you can look at the deep in the money call options for say $77 or $75 strike price. Note that the $77 call will be cheaper than the $75 call. One strategy when buying calls is to take advantage of the wide spread between the bid price and the ask price of SVXY options, especially on days when volatility spike reduces the price of SVXY. You already know that in the past six-years, the price of SVXY has increased from $5 to over $80. So, the idea here is to buy a $75 call expiring this Friday (September 15,2017). If you buy 1 call, you get the right to buy 100 shares of SVXY on the date of expiration (September 15, 2017). After buying the call you would look to sell it back on the ask price. If SVXY had a one-dollar wide spread, and you are successful selling it back, you would make $100 per contract. Traders often buy options with market orders or by paying the asking price. From our experience, it is possible to buy calls at the bid price. But this works best on days when SVXY is going down in price. For example, you input your order to buy the September 15, 2017 expiration call with a $77 strike with a limit order to buy at the bid price and wait. You might be surprised how many times your order will be filled at the bid price and not the ask price. Once you have purchased the call, you can enter another order to sell your call at a higher price which can either be the ask price or a price which is more than the bid price. Some trading platforms will allow traders to create specific criteria for buying options. It is recommended to see if you can default the platform to always start with a limit order at the

72 71 current bid price. Having defaults has been especially helpful when trading on the go and during times when orders need to be entered quickly. There are plenty of days when getting call option orders filled on the bid price is difficult. It might be beneficial to modify buy orders to a price near or at the middle of the bid-ask spread. Our 30% swing trade idea of trading SVXY weekly calls is to engage in multiple trades where we are able to get into trades, take profits and free up capital. As an example, if you buy 1 call for $4.20 (paying $420) and sell it for $4.75 (realizing $475), you would make a profit of $55 on a $420 investment which comes to a ROI of (55/420) x 100 = 13.09% ROI per day. Assuming that you are successful in executing one such transaction each day, then your annual ROI for 5 days a week & 52 weeks a year would come to a whopping 13.09% x 5 x 52 = 3,404%. Note that you may not be able to do such a trade each trading day. The point is, always calculate what ROI you are getting if you close the trade and if in your mind the ROI is reasonable, you should close the trade and free up capital that can be used for the next trade. Another way to do this would be to buy 10 call contracts instead of 1 call contract. This was my preferred method in the past. This would work very well when SVXY increases in price after you purchase the calls. But if SVXY drops in value and you are unable to sell the calls for a profit, you have to sell your calls at a loss or exercise the call option. Note that 1 call contract is for 100 shares. 10 call contracts would mean you should have funds to buy 10 x 100 = 1,000 SVXY shares when the options are exercised. The best way to decide how many call contracts to buy is to evaluate the worse case scenario do you have funds to take delivery of the shares against the calls that you have if and

73 72 when the calls are exercised? If the answer is no, it could result in a large headache and a margin call. If you are careful when buying calls, there should be no fear to have the option exercised and taking delivery of the shares against the call. I was forced to take delivery of 300 shares of SVXY after three call options were exercised on a Friday. On Monday, when the market opened, I was able to sell the 300 shares at a 3$ profit earning 900$. To summarize the SVXY weekly call buying strategy, first you decide on the number of call options you want to commit to, based on your liquidity. Then you buy the weekly calls for strike prices which are $2 to $4 dollars below the current SVXY price. You wait for the SVXY price to increase which should result in the value of the calls also rising. In case the SVXY price falls, you exercise your call options, take delivery of the shares and wait to sell the shares for a profit. Also, since SVXY is volatile, you can buy weekly calls on daily lows and sell the calls on daily highs. You can use any charting system provided by your brokerage to make an assessment of identifying daily lows or highs. Similar to buying shares of SVXY when the High/Low column is fully red, you could use this tool to buy options instead.

74 73 Buying Deep in the Money Monthly Calls Buying SVXY deep in money monthly calls is also an alternative. This gives you more time. One might realize a bigger move to the upside netting more profit or simply more time for SVXY to return to a profitable level. The disadvantage is the option will cost more resulting in decreased buying power. We like this strategy of buying deep in the money monthly SVXY calls the best when SVXY has had a significant drop in price. If you bought deep in the money next month expiry calls when there was an appreciable SVXY price fall, there are good chances that you will be able to sell the calls at a profit later. Not only can you sell your calls for profit, the margin of profit can be more if SVXY continues to rise as we move closer to the expiry (assuming Implied Volatility does not drop and theta decay doesn t destroy the value of the options). There are two distinct disadvantages of buying calls. This first is calls decay with time, this means that if you buy an option and the price stays the exact same over several days, the option will decrease in value as time goes on. The second is that after a big move, the implied volatility (IV) of an option usually increases. This will increase the price of an option. Overtime the IV will drop and so will the value of the option. My preferred method is to not hold the monthly SVXY calls till expiry. I have learnt that the call value could rise initially and then as we approach the expiry date, the calls could lose value either because of theta decay, SVXY decreases in value or the IV drops. You can realize amazing ROI as well. For example a deep in the money call bought for $6.95 (cost $690) and sold for $8.25 (proceeds realized $825) after 15 days would give you a profit of $825 minus $695 = $200. This would come to an ROI of (200/690) x 100 which is 28.98% for 2 weeks. This would come

75 74 to an annualized ROI of 28.98% x 2 times a month x 12 times a year= %. Note that to achieve such a high annual ROI, you would need to make such a profitable trade every 15 days and there is no guarantee of that happening. The point we are making here is, you should keep the ROI always in mind and exit the trade as soon your target ROI is reached. This way, you will be able to realize profits, free up capital and increase your cash balance. Never buy SVXY out of the money Weekly or Monthly Calls People make the grave mistake of buying weekly or monthly calls which are out of money (in this example an 85$ call or a 90$ call, when SVXY current price is 80$). They go for this choice because these calls are priced much cheaper and they are confident that SVXY price can increase a specific dollar amount in a week or a month. If you get lucky and SVXY price increases after you have purchased the call, you will be able to make a profit. But with time, the call will lose value (called theta decay and we will cover theta in later chapters) and so for you to make profit, SVXY price has to rise substantially higher to counter the theta decay. If you buy a out of money weekly or monthly SVXY call, there are possibilities of you losing most or all of the money that you spend on the call because of theta decay and because SVXY price continued to drop by its weekly expiry.

76 75 Selling SVXY at the money naked puts after a huge volatility spike While brokerages allow you to buy calls and puts, very few of them allow you to sell naked puts. If your broker does not allow you to sell naked puts (or sell naked calls), you should try and switch your brokerage. Selling naked puts is a bullish position that can be utilized in our swing trade strategy. A huge volatility spike would result in a big drop in SVXY prices. You can look at SVXY price chart to see the dates when SVXY saw a big drop in price. You will notice that as volatility returns to normal and calm returns, SVXY price rose. Below are several dates, when SVXY prices saw significant declines. Feb 14, 2017 to Feb 23, 2017 Price dropped from $67.47 to $ March 20, 2017 to March 23, 2017 Price dropped from $71.03 to $65.66 March 29, 2017 to April 13, 2017 Price dropped from $72.72 to $60.66 May to May 17, 2017 Price dropped from $79.56 to $65.03 August 7, 2017 to August 11, 2017 Price dropped from $91.97 to $71.68 August 16, 2017 to August 17, 2017 Price dropped from $81.83 to $68.24 To date, SVXY has recovered all the losses in due course of time because of the way it is designed. While this might not always happen, it continues to set higher highs.

77 76 When you see a big SVXY price drop, you can sell at the money SVXY naked puts, one month out. For example, if the current price of SVXY is $71.68 on August 11, you sell the $71 or the $72 naked put. You sell the put when you feel that the price drop is done. Alternatively, once the price drop is finished and you see an upward price trend, you can sell this put. When you sell such a put, you will be able to collect a premium. In the coming weeks, you hope to see SVXY increase in price. If it does, the value of the naked put that you sold will fall. You decide to close the put by buying the put back when you feel that you have achieved your ROI. Selling SVXY in the money weekly / monthly naked puts In calm market conditions, when there is little to no volatility, you can make money by selling in the money weekly or monthly SVXY naked puts. If SVXY is currently trading at $71.68, then selling a put with strike price of $68 or $69 will be considered an in the money put. Note that the premium for a $68 put will be lesser than a $69 put. When you sell the put, you collect a credit. To maximize your return, we recommend selling for as much or more than the asking price. An important thing to remember here is if the price of SVXY falls and is say $65, on the day of option expiration, you will have to pay $6,800 (if you sold the $68 strike price put) or $6,900 (if you sold the $69 strike put) to take delivery of 100 shares of SVXY. The good news is the credit you collected can help offset the cost. You can still attempt to buy the put back before the option expires to prevent from purchasing the shares.

78 77 Disclosure: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. As an investor, you are fully responsible for any investment decision that you make.

79 78 Chapter 10 30% Portfolio Swing Trade Buying VXX, UVXY Long Dated Put Options This chapter deals with trading VXX and UVXY puts to make regular profits. The spread between the bid price and the ask price of UVXY put options is wider and your strategy should be take advantage of this wide spread. On the other hand, the bid and ask price for VXX puts are usually narrower. Note that there are no options for TVIX. What are Puts in Options? Put options give the holder the right to sell an underlying asset at a specified price (the strike price). The seller or writer of the put option is obligated to buy the stock at the strike price. If you are bearish on a stock, you buy puts. If VXX is trading at $45, then puts with a strike price higher than current price, are called deep in the money. Puts with strike price of $44 or lower than the current price, are called out of the money puts. Puts with 45$ strike price are at the money. Just like calls, we have weekly as well as monthly puts. Buying Deep in the Money Long Dated VXX Puts at the top of the Volatility Spike The strategy is to buy puts which are 2 to 3 months out (For example, if we are in September, it would be prudent to buy

80 79 puts which expire in November, December or January). Also, buying deep in the money puts after completion of a good enough volatility spike is a sure way of making money. If you observe volatility, you would notice that the spike can continue for a few days. Then, the volatility starts falling. This is the time to make an entry into this trade with a large capital outlay. This is the time when you will find the put price (for a given deep in the money put ) to be the cheapest. Having a longer expiration and a strike price that s appreciably above the current price will help to reduce risk and increase probability of profiting. Of course, buying puts which expire sooner and at strike price which are closer to the current price (even if the put is out of the money ) will increase your risk. My experience is that one should take profits quickly due to the increased risk. Considering this, I have found that buying puts which are 3 months away with a strike price 30% over the current price is a guaranteed winner if you buy the puts once the volatility has started falling after reaching the peak. If you adopt this strategy, you can boldly allocate a sizable portion of your capital to buy such puts. After you buy the puts, you have to play the waiting game as volatility mean reverts. As volatility drops, so will the price of VXX and your puts will increase in value. When to cash out is the billion-dollar question. I never wait for the option expiry, because volatility might rise again while the option suffers from time decay. Taking profits when your expected ROI has been reached is a safe approach. One can also sell the majority of the position when your expected ROI is reached and let a small position ride. It is natural that the larger the position someone takes, the quicker they will exit due to increased fear and anxiety. Having a small position will help you feel comfortable holding for longer periods of time and potentially capture bigger gains.

81 80 Typically, I have bought deep in the money VXX puts for $10.50 per put (investing $1,050 per contract) and sold them for $13.50 (realizing $1,350) in 2 weeks time. Thus, your profit is $1,350 minus $1,050 = $300 on an investment of $1,050. Your ROI for a 15-day period comes to 28.57%. If every 15 days you are able to make a trade like this, your annual ROI would be 28.57% x 2 times a month x 12 times a year which is %. Note that you may not be able to make so many successful trades. If you are committing a large capital for such a trade by buying 20 or 50 or 100 puts, do your best to enter when you believe volatility has peaked. For those who do not feel comfortable calling tops, a safer method is to wait for the first red day for VXX/UVXY and then enter. This method will reduce the chance of the trade continuing to go against you. Buying Deep in the Money Long Dated UVXY Puts at the top of the Volatility Spike Trading long dated deep in the money UVXY puts is similar to trading VXX puts. Note that the difference between the bid and ask price is much more in UVXY puts. So, when you place your order, try to get a good price (either by buying at bid price or specifying a strict limit price which is between the bid and the ask price). Never buy a UVXY put for the ask price. Another difference is, since UVXY is a 2X leveraged instrument, your returns will be more than VXX. However, when you try to sell the puts, you will face the same problem posed by the wide bid and ask prices and you need to specify a limit price to maintain your profitability.

82 81 A quick note on Deep in the Money Long Dated VXX & UVXY Puts You might be wondering why buy deep in the money puts dated 3 months out. They are very expensive and cheaper options are available. Our objective is to earn a better ROI while reducing risk. It does not matter if you buy a put for $5 or for $11. What matters is how soon you can sell the put for a profit (with minimal risk). Which is better? Buying a put for $5 and selling it for $5.75? Or buying a put for $11 and selling it for $13? Let us calculate the ROI for each case. When buying a put for $5 and selling it for $5.75, your profit is $75 on a $500 investment, which is a ROI of (75/500) x 100 = 15%. On the other hand, buying a put for $11 and selling it for $13 (200 gain) has an ROI of (2/11) x 100 = 18.18% To elaborate, if you had a fixed amount of capital say $1,150 to spend, you could buy one $11 put or two of $5 puts. The above calculation shows that your profitability will be more with the $11 put. Day Trade Deep in the Money Long Dated VXX & UVXY Puts There are days when VXX & UVXY will trade in a range. On such days, you can buy VXX long dated deep in the money puts when VXX s price is at daily highs. You do a quick turn around and sell the puts the intraday or shortly after as VXX price falls. VXX dropping in price will increase the value of the put. As compared to the strategy previously mentioned (of outlining increased capital to buy puts immediately after the peak volatility spike has been reached), this strategy allows you to

83 82 free up your swing trade capital and add profits to your portfolio balance. Buying a put for $11.95 (spending $1,195) and selling it for $12.35 (realizing $1,235) in 2 days would give you a profit of $1,235 minus $1,195 = $40 which would be an ROI of (40/1235) x 2 trade a week x 52 weeks = % annual ROI. Why Not to buy Weekly Puts Options with near-term expirations are considered risky and not recommend. If you buy an out of the money weekly put (for example a UVXY put with strike price of $29, when UVXY is trading at $30), you would lose the value paid for the put if UVXY spikes and closes the week at a price of $33. Even buying at the money or deep in the money weekly put is risky for the above reason. Why at the money long dated puts could still be risky? I used to buy UVXY / VXX at the money puts 1-to-2 months out (on volatility spikes) and this strategy worked effectively. However, during the period of July 15 th to Sep 1 st 2017, we saw 5 volatility spikes as follows: July 24 th to July 28 th UVXY price spiked from $ to $30.19 August 7 th to August 11 th UVXY price spiked from $29.04 to $45.62

84 83 August 16 th to August 17 th UVXY price spiked from $30.29 to $41.19 August 22 nd to August 24 th UVXY price spiked from $30.62 to $34.1 September 1 st to September 5 th UVXY price spiked from $28.36 to $34.66 Such price spikes make even the at the money puts 1 to 2 months away, a risky proposition. Such volatility spikes demand that you have 50% of your portfolio in cash to defend your 20% core short position. There is no need to buy puts if you don t see an opportunity Often, we see VXX and UVXY open down on the day and continue to decline. On these days you do not need to open new positions. You could instead close existing positions by selling previously bought puts. There is no need to overtrade on a day like this and buy more puts. Buying a deep in the money long dated put on a day like this does not make sense because the moment a small spike happens, your put value will be lower. Disclosure: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular

85 investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. As an investor, you are fully responsible for any investment decision that you make. 84

86 85

87 86 Chapter 11 30% Portfolio Swing Trade Selling VXX, UVXY Naked Calls After I started shorting UVXY and TVIX I noticed it was working well but others were making a lot more money. It also became apparent that some were also losing significant amounts. Most of the big profits and losses came from selling naked calls. One experienced volatility trader even commented that smart money is the one that sells UVXY & VXX naked calls. In my existing Scottrade account, I am not permitted to sell naked calls. What I can do is to first buy VXX or UVXY and then sell a call against the shares held. This is called a covered call. This goes against the goal of being short volatility. Determined to learn about selling naked calls, I proceeded with opening an account with another brokerage. This chapter discusses selling UVXY and VXX naked calls to make profits on a regular basis. Free Money - Selling deep out of the money Long Dated UVXY Calls The easiest free money that you can earn is to sell deep out of the money long dated UVXY calls. Let us take an example. Today s date is September 15, You look for UVXY options chain 4 months away - Jan 19, We will examine how much you would get for selling the calls below:

88 87 One contract of Jan 19, 2018 $88 strike price for $2.46 and you will pocket $246 One contract of Jan 19, 2018 $89 strike price for $2.42 and you will pocket $242 One contract of Jan 19, 2018 $90 strike price for $2.40 and you will pocket $240 One contract of Jan 19, 2018 $91 strike price for $2.38 and you will pocket $238 For the above 4 contracts, you can keep the $246 + $242 + $240 + $239 = $966 as there is a 97% probability that all the 4 calls will expire worthless. You will achieve the maximum profitability when you sell naked calls after a volatility spike. You will get rich call premium and the call that you sell will expire worthless with time, once the calm has returned. In the previous example, selling one naked call (Jan 19, 2018 $88 call) for about $246 will reduce your buying power by approximately $750. The amount of reduced buying power will change based on the strike price of the option, how much implied volatility the option has and day-to-day fluctuations in UVXY. Each broker has rules for how much capital is required to be reserved for naked calls. It is best to ask your broker about theirs. We will get a nice ROI for this trade. Since your margin gets reduced by $750, and since the call will expire worthless in 4 months, your profit is $246 on an investment of $750. This comes to a ROI of (246/750) x 3 more times a year x 100 = 98.4% per year. You can maximize your ROI even further, by closing the transaction i.e. buying back the call within a week or 10 days, or

89 88 when your ROI target is met. Here is an actual real life example. I was able to close one naked call at $210 within a week (the call was sold at $242), yielding a profit of $32 on an investment of $750 (because this was the amount by which your buying power was reduced). The effective ROI is (32/750) x 52 transactions, one each week x 100 = %. You need to decide if you want to put in the effort of scalping instead letting the options expire. The advantage of closing out the call in a week or a month is you are not only realizing profits, you are also freeing up your buying power. However, note that sometimes volatility spike will not come as often as you desire. After you exit the trade, it could be months before you sell options and make money again. With the cash earned from the trade, you can allocate it to selling calls during the next volatility spike. Here are some tips for selling out of the money long dated calls When selling a call, the farther months you go, the lesser risk you will have Go for the maximum strike price to reduce your risk Enter your naked call sell order at ask price to make an attempt to increase your ROI. If the order is not fulfilled, give it more time to get filled. If that does not work, try to sell the call in the middle of the spread. If you are inclined to do multiple trades, enter an order to sell the call the same day at ask price or a little higher than the ask price. Of all the strategies, this strategy of collecting premium by selling long dated deep out of the money calls on days with huge volatility spikes has the highest reward / risk ratio. It is recommended to start small with this strategy. If you sell a call too soon, it can quickly double or triple in value and result in your buying power reduced drastically and you getting even a

90 89 margin call. As a general rule of thumb, it is smart to keep your account in 50% cash while selling naked calls. If you are new to this strategy, it might be best to start by keeping 70% of your account in cash. This strategy can see big swings both against you and in your favor. Selling weekly at the money or deep in the money naked calls We have already discussed this strategy in Chapter 8, where you sell deep in the money UVXY naked calls if you don t get shares to short and you want the sold naked calls assigned. Let us discuss that again with an example. Assume that UVXY is trading currently at $26 on Monday. You sell as many UVXY weekly at the money or deep in the money naked calls as you can handle based on your cash balance, if things go the other way. So, you go ahead and sell one $23 strike call for the Friday expiry at $2.00 per call and you would receive $200. If UVXY falls to $ 22 on Friday close, you get to keep the $200. This is free money, right? But things could go wrong. On Friday, if UVXY closes at $24, then the call that you sold will be assigned, which would result in you being short 100 shares of UVXY and you would need to shell out an additional $2,300 for these 100 shares. The net result is you are short 100 shares UVXY and you spent $2,300 minus $ 200 = $ 2,100 shorting these shares. Effectively this is like saying that you shorted 100 UVXY shares at $21 per share, while UVXY closed at $24. This is a method that can be used to get assigned short shares. The shares could then be held in a core position or traded short term. If things go the other way, at least you have 100 short

91 90 shares which itself is an achievement because finding shares is a challenge. To summarize, it is all about money management and liquidity. If you go all in, in various transactions, it will not help you. On the other hand, if you plan ahead and make trades thoughtfully, you can come out a winner. Selling monthly at the money or deep in the money naked calls This strategy is similar to selling weekly at the money naked calls, discussed above. Since you are going further out, the chances of you pocketing the entire call premium received is much higher. Disclosure: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. As an investor, you are fully responsible for any investment decision that you make.

92 91

93 92 Chapter 12 30% Portfolio Swing Trade Selling at the money UVXY Straddles To implement the strategy in this Chapter, you should have the ability to sell naked calls as well as puts. At any point in time, you sell an equal number of UVXY (at the money) calls and puts expiring on the same date, 30 to 45 days out. There are some interesting things that emerge out of this strategy. Also, since you are selling both a naked call and a naked put, you don t have to worry which direction UVXY is headed. We all know that UVXY is designed in such a way that it is headed to zero, & it will never touch zero because it will reverse split before that. Having said that, no one can predict how the current month VIX futures (M1) and next month futures (M2) will behave. So, it could very well happen that while you were expecting UVXY price to fall, it instead rises and continues to do so for several days in a row. The logic of this trade is, if UVXY s price falls, the put price will increase while the call price will fall. On the other hand, if UVXY price rises, the call price will rise while the put price will fall. Thus, you are protected in terms of profits in calls offsetting losses in puts and vice versa. But since you are selling both a call and a put, you tend to have theta decay working in your favor. The longer you hold the options, the more theta will decay the option. It also helps if UVXY has a high implied volatility ranking at the time of entering the trade. If the IV drops along with theta you can make increased profits.

94 93 Theta Decay Theta is a measure of the rate of decline in the value of an option due to the passage of time. It can also be referred to as the time decay on the value of an option. If everything is held constant, the option both the call and the put that you sold - loses value as time moves closer to the maturity of the option. Selling naked calls and naked puts with expiry of 30 to 45 days ahead Since we are trying to gain advantage of theta decay, you need time on your side. For this reason, you don t implement this strategy for weekly puts. You sell one naked call and one naked put (or equal number of calls and puts) 30 to 45 days out. Also keep in mind that you don t have control on the option pricing. There is already a bid and a ask price and you have to enter your trade around that. When you opt for a straddle, only proceed with the trade when the premium that you get for selling one call is equal to the premium you will get when selling one put. The ROI Below are the actual results for this strategy. All trades were for UVXY and were entered (i.e. the call as well as the put was sold) on Friday, September 8, All trades were exited exactly 1 week later - that is on September 15, 2017.

95 94 Note that the ROI is calculated based on the amount by which the buying power was reduced. 1 Nov 17, $29 UVXY Call Sold for $6.90 on Sep 8, 2017 Bought back for $4.25 on Sep 15, 2017 Profit on Call = $690 minus $425 = $265 1 Nov 17, $29 UVXY Put Sold for $7.44 on Sep 8, 2017 Bought back for $8.85 on Sep 15, 2017 Loss on Put = $744 - $885 = $141 Net Profit = $265 - $141 = $124 Total Investment = $1,434 Buying power reduction = $1,100 ROI = (124/1100) x 52 weeks x 100 = % 1 Oct 20, $28 UVXY Call Sold for $4.80 on Sep 8, 2017 Bought back for $2.75 on Sep 15, 2017 Profit on Call = $480 minus $275 = $205 1 Oct 20, $28 UVXY Put Sold for $4.80 on Sep 8, 2017 Bought back for $6.1 on Sep 15, 2017 Loss on Put = $480 - $ 610 = $130 Net Profit = $205 - $130 = $75 Total Investment = $960 Buying power reduction = $1,000 ROI = (75/1,000) x 52 weeks x 100 = 390%

96 95 1 Oct 13, $28 UVXY Call Sold for $4.19 on Sep 8, 2017 Bought back for $2.13 on Sep 15, 2017 Profit on Call = $419 minus $ 213 = $ Oct 13, $28 UVXY Put Sold for $4.15 on Sep 8, 2017 Bought back for $5.60 on Sep 15, 2017 Loss on Put = $415 - $ 560 = $145 Net Profit = $ $145 = $ 61 Total Investment = $834 Buying power reduction = $1,000 ROI = (61/1,000) x 52 weeks x 100 = % The Risks when you sell at the money naked Call and Put Like every strategy, this also has risks. Let us say when UVXY was trading at $29, you sold Nov 17, $29 strike one naked call for $6.90 and one naked put for $7.44. First you add the premiums that you have collected. In this case, the total comes to $6.90 plus $7.44 = $ This is your profitability range. This means that your trade is profitable if UVXY stays in a price range of ($29 minus $14.34) and ($29 plus $14.34) i.e. $14.66 and $43.34 till option expiry. If any time before the expiry of options i.e. till November 17, UVXY price crosses this profitability range, your trade will turn into a loss.

97 96 When to exit this Trade I prefer to exit the trade anywhere from 7-to-14 days from when I started the trade. This helps me to ensure that I realize some profits, which adds to my cash balance. This also helps free up my buying power in my trading account, so that I can enter new trades. Finally, by closing both the call and the put, you are ensuring that you are not risking the UVXY going above or below the profitability price range. Same Day Results It could very well happen that once you sell an equal number of at the money naked calls and puts (30 to 45 days ahead), you may be able to exit the trade the same day itself at a huge ROI. Below is an example of the actual trade on September 8, Oct 27, $31 UVXY Call Sold for $6.40 on Sep 8, 2017 Bought back for $5.17 on Sep 8, 2017 Profit on Call = $640 minus $517 = $123 1 Oct 27, $31 UVXY Put Sold for $6.70 on Sep 8, 2017 Bought back for $7.40 on Sep 8, 2017 Loss on Put = $670 - $740 = $70 Net Profit = $123 - $70 = $53 Total Investment = $ 1310 Buying power reduction = $1,400 ROI = (53/1400) x 5 days a week x 52 weeks x 100 = %

98 97 As you can see from above, both the naked call and put were sold and bought the same day, giving you a huge ROI of %. Note that you may not be able to do such trades, day after day, on each trading day for the whole year. The point is, it makes sense to close the position and exit the trade if your ROI objectives have been met. Disclosure: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. As an investor, you are fully responsible for any investment decision that you make.

99 98 Chapter 13 20% Portfolio Core Short Position This part of the strategy is my favorite as this requires very few transactions and gives you a handsome ROI over time. You take advantage of the power of the decay of these volatility based products as well as compounding. The Power of Time and Compounding Before we discuss the 20% core strategy in detail, let us understand what results compounding with time can achieve. The Oracle of Omaha, Warren Buffet, was interviewed sometime in the middle of August 2017 when Dow Jones Industrials Average was around 22,300. Buffet remarked that he expects the DOW to reach 1 million after 100 years i.e. in Many people commented that Buffet is getting old and he has turned senile. But if you notice, Buffet was fairly bearish. Against a compounded 5.5% increase in the DOW per year, he was taking a very modest 3.9% compounded return per year for the next hundred years. Since in 2017, DOW is at 22,300, the next year it will grow by 3.9% or will become 22,300 x = 23, Every year, it would increase by 3.9%. So, in the year 2117, we can expect DOW to be 22,300 x x x (multiply hundred times) = 1,022, (1 million, twenty two thousand and nine hundred and sixty two).

100 99 Our 20% core short strategy works on this principle. Note a big difference here. Buffet took a compounded 3.9% increase in the DOW per year. UVXY, TVIX and VXX decay rate is much higher than this. Imagine your profitability, if you can hold these shorts long term. Core Shorts and Additional Shorts for TVIX and UVXY You initiate shorting for example 100 shares of TVIX, on a day when TVIX price is up several percent. This initial quantity of shares that you shorted will be referred to as core shorts. It is not necessary that you wait for TVIX to be substantially up, to start the core short. You can do this any day you wish, because we are aiming for a very long-term play here. Here is a personal example. UVXY was trading around $32. I wanted to start my initial core short but I could not manage to get shares to short for 15 straight days. (Also, at that time, I never knew that one can sell deep in the money weekly naked calls or buy deep in the money puts and have the options assigned to end up with short shares). Finally, UVXY reached its all time low of $28 and I was successfully able to start my core short because I was able to get shares to short from my brokerage. During next month, UVXY rose from $28 to $44 (during which period, the shares were just not available to short, otherwise, I would have increased my core). Seven weeks later, it traded at $24.75 (at the time of the writing of the book), which is lower than my entry. The point of this 20% core short strategy is any day is a good day to short UVXY or TVIX because your intention is to hold these shorts long term. It will increase profits if you can short on a price run up.

101 100 Let us assume that you initiated your core shorts of 100 TVIX shares when TVIX was trading at $17. Based on the analysis of historical data, the 2x leveraged funds like TVIX and UVXY lose 20% of their value in about 30 to 45 days. When TVIX s price falls 20% (i.e. when it trades at $13.60), you would notice that less buying power is needed to hold the current short. You short more TVIX shares at this price. This additional quantity that is shorted is called additional shorts. You continue this activity of adding shares every time TVIX falls an additional 20%. The below tables show the TVIX price and the additional short quantities that you would be able to short, without needing any additional buying power. TVIX Price in $ Initial Short Additional Short Total Short Quantity , , , ,220 3, ,750 8,250

102 101 A couple of points here. While we started with a TVIX price of $17 and end up with a price of $1.46, in real life you would see at least 2 reverse splits and this table would need to be adjusted to account for reverse splits. But the situation will not change if there was a 4:1 split, because when the split happens, you would be dividing the number of shares by 4 and multiplying the price by 4. Another important thing to note is you don t need any additional capital to add these additional shorts. Since TVIX price has fallen, you have made unrealized profit. You are using the unrealized profit or freed up capital to short more. If you don t understand the above statement, look at it this way. You have capital freed up because UVXY/TVIX has dropped in price. This requires less money to hold the short because the shares are worth less and margin requirement is also lower. Let us analyze the first two rows. You started the initial short for 100 shares at $17 spending $1,700. When TVIX s price is $13.6, if hypothetically you would have covered these shares at this price, you would have made a hypothetical profit of $1,700 minus $1,360 = $340. So effectively your $1,700 would now have become $1,700 + $ 340 = $2,040. Since TVIX is trading now at $13.60, you can short 2,040 divided by = 150 shares. So instead of covering our 100 shares core short, we add 50 shares short when TVIX s price reaches $13.6 This strategy effectively requires 12 more transactions. 11 transactions are adding additional shorts with every 20% price fall. The 12 th transaction is when you cover all the shorted shares on the 366 th day or whenever TVIX had fallen another 20% below $1.46 or when TVIX price has reached $ Once you cover all the shares, you will end up with a huge ROI.

103 102 An important point to note is while you started with 100 shares short, you ended up with a total of 8,250 shares short. This is not scary just for the simple fact that the price of TVIX has also fallen from $17 to $1.16 when you would cover. To summarize, you started with shorting 100 shares at $17 for an investment of $1,700. In the end, you covered 8,250 shares at a price of $1.16. Thus, your net profit on a $1,700 investment after approximately 12 to 14 months is $ 12,738. Please see the tables at the end of this chapter for an exact profitability calculation for TVIX, UVXY, and VXX. A very important point to keep in mind is with the additional shorts, it will affect your margin account. You would need more funds to accommodate the growing position in your account. This is where the 30% swing trade strategies come into play. If you were doing your daily / weekly 30% swing trade strategies profitably, those profits would get added to your existing 50% cash balance. This would ensure the success of this 20% core short strategy. There is no compulsion that you have to close the trade fully when TVIX price reaches $1.16 (in the estimated 12 to 14 months). You can continue this for many more years for further profits. Since your account will be growing (on account of the profits from the 30% swing trade strategy as well as this 20% core short strategy), you would of course need to pay attention to your cash balance and liquidity. Also, you can implement the concept of laddering where every month, you start a new initial short of 100 shares and continue to add more shorts with 20% price decline. So, every subsequent month your additional shorts increase. Contact us at if you want the laddering model for UVXY and TVIX.

104 103 The below table shows the core and additional shorts for UVXY, where the initial short was established at $29. UVXY Price in $ Initial Short Additional Short Total Short Quantity The core short was done with 100 shares at $29 UVXY price. You cover the 8,753 shares at $1.992 (20% below the last price of $2.49) and you get a net profit of $23,250 on an initial short investment of $2,900.

105 104 Do we add more shorts at both a 20% price drop for TVIX and UVXY as well as price spike? Yes. If TVIX or UVXY price spikes, you short them based on the 30% swing trade strategy. Once volatility drops and calm returns, you are covering the shares, and realizing profits. The gains add to your other holdings. In this 20% portfolio strategy, you are having additional shorts with every 20% price fall, which you are holding for the next 1 year or longer. Core Shorts and Additional Shorts for VXX Since VXX is not a leveraged fund, your ROI will be less than that of TVIX and UVXY. The below table shows the core and additional shorts for UVXY, when the initial short was established at $47. Also, additional shorts are done when VXX price falls 10%. VXX Price in $ Initial Short Additional Short Total Short Quantity

106 105 VXX Price in $ Initial Short Additional Short Total Short Quantity Here you cover the 1,750 shares at $13.25 (20% below the last price of $ 14.75) and you get a net profit of $17,602 on an initial short investment of $4,700. Curb Your Temptation To Cover The Core and Additional Shorts As time goes by, you will see the price of TVIX and UVXY falling. At times, you will have a temptation to cover. Do not make this mistake as you would be giving away the advantages of decay and compounding which you would have started some months back. Stick to the plan of holding short for the long run. Percentage of UVXY, TVIX and VXX shorts in your 20% Portfolio You are free to decide what mix of these you should have in 20% of your portfolio. As easy way to implement this would be to have

107 106 8% long term shorts in UVXY, 8% long term shorts in TVIX and 4% long term shorts in VXX Profitability Calculation of UVXY, TVIX and VXX The below tables show what would have happened if you had started with an initial short, covered when price falls 20%, and then added shorts (at these reduced prices) based on the total amount available, and continued this exercise for a year-long period. UVXY Price in $ Beginning Shorted Shares Additional Short Quantity $ Short Value = 100 x $29 = $2,900 Covered shares = 100 Covered Price = $23.2 Covered Value = 100 x $23.2 = $2,320 Profit = $2,900 - $2,320 = $600 Final Capital = $2, = $3,500 $ Short Value = 150 x $23.2 = $3,480 Covered shares = 150 Covered Price = $18.56 Covered Value = 150 x $18.56 = $2,784 Profit = $3,480 - $2,784 = $696 Final Capital = $3, = $4,196 $ Short Value = 225 x $18.56 = $4,176 Covered shares = 225 Covered Price = $14.85 Covered Value = 225 x $14.85 = $3,341 Profit = $4,196 $3,341 = $855 Final Capital = $4,196 + $855 = $5,051 Total Short quantity

108 107 Price in $ Beginning Shorted Shares Additional Short Quantity Total Short quantity $ Short Value = 340 x $14.85 = $5,049 Covered shares = 340 Covered Price = $11.88 Covered Value = 340 x $11.88 = $4,040 Profit = $5,051 - $4,040 = $1,011 Final Capital = $5,051 + $1,011 = $6,062 $ Short Value = 510 x $11.88 = $6,059 Covered shares = 510 Covered Price = $9.50 Covered Value = 510 x $9.5 = $4,845 Profit = $6,062 - $4,845 = $1,217 Final Capital = $6,062 + $1,217 = $7,279 $ Short Value = 765 x $9.50 = $7,267 Covered shares = 765 Covered Price = $7.60 Covered Value = 765 x $7.60 = $5,814 Profit = $7,279 - $5,814 = $1,465 Final Capital = $7,279 + $1,465 = $8,744 $ ,150 Short Value = 1,150 x $7.60 = $8,740 Covered shares = 1,150 Covered Price = $6.08 Covered Value = 1,150 x $6.08 = $6,992 Profit = $8,744 - $6,992 = $1,752 Final Capital = $8,744 + $1,752 = $10,496 $ ,725 Short Value = 1,725 x $6.08 = $10,488 Covered shares = 1,725 Covered Price = $4.87 Covered Value = 1,725 x $4.87 = $8,400 Profit = $10,496 - $8,400 = $2,096 Final Capital = $10,496 + $2,096 = $12,592

109 108 Price in $ Beginning Shorted Shares Additional Short Quantity Total Short quantity $4.87 1, ,585 Short Value = 2,585 x $4.87 = $12,589 Covered shares = 2,585 Covered Price = $3.9 Covered Value = 2,585 x $3.9 = $10,081 Profit = $12,592 - $10,081 = $2,511 Final Capital = $12,592 + $2,511 = $15,103 $3.9 2,585 1,285 3,870 Short Value = 3,870 x $3.90 = $15,093 Covered shares = 3,870 Covered Price = $3.11 Covered Value = 3,870 x $3.1 = $12,035 Profit = $15,103 - $12,035 = $3,068 Final Capital = $15,103 + $3,068 = $18,171 $3.11 3,870 1,973 5,843 Short Value = 5,843 x $3.11 = $18,172 Covered shares = 5,843 Covered Price = $2.49 Covered Value = 5,843 x $2.49 = $14,549 Profit = $18,171 - $14,549 = $3,622 Final Capital = $18,171 + $3,622 = $21,793 $2.49 5,843 2,910 8,753 Short Value = 2,910 x $2.49 = $37,382 Covered shares = 8,753 Covered Price = $1.99 Covered Value = 8,753 x $1.99 = $17,436 Profit = $21,793 - $17,436 = $4,357 Final Capital = $21,793 + $4,357 = $26,150 Net Profit = $26,150 - $2,900 = $23,250 on a $2,900 investment

110 109 TVIX Price in $ Beginning Shorted Shares Additional Short Quantity $ Short Value = 100 x $17 = $1,700 Covered shares = 100 Covered Price = $13.6 Covered Value = 100 x $13.6 = $1,360 Profit = $1,700 - $1,360 = $340 Final Capital = $1,700 + $340 = $2,040 $ Short Value = 150 x $13.6 = $2,040 Covered shares = 150 Covered Price = $10.88 Covered Value = 150 x $10.88 = $1,632 Profit = $2,040 - $1,632 = $408 Final Capital = $2,040 + $408 = $2,448 $ Short Value = 225 x $10.88 = $2,448 Covered shares = 225 Covered Price = $8.70 Covered Value = 225 x $8.70 = $1,957 Profit = $2,448 - $1,957 = $491 Final Capital = $2,448 + $491 = $2,939 $ Short Value = 340 x $8.70 = $2,958 Covered shares = 340 Covered Price = $6.97 Covered Value = 340 x $6.97 = $2,370 Profit = $2,939 - $2,370 = $569 Final Capital = $2,939 + $569 = $3,508 Total Short quantity

111 110 Price in $ Beginning Shorted Shares Additional Short Quantity $ Short Value = 510 x $6.97 = $3,555 Covered shares = 510 Covered Price = $5.57 Covered Value = 510 x $5.57 = $2,841 Profit = $3,508 - $2,841 = $667 Final Capital = $3,508 + $667 = $4,175 $ Short Value = 765 x $5.57 = $4,261 Covered shares = 765 Covered Price = $4.45 Covered Value = 765 x $4.45 = $3,404 Profit = $4,175 - $3,404 = $771 Final Capital = $4,175 + $771 = $4,946 $ ,150 Short Value = 1,150 x $4.45 = $5,117 Covered shares = 1,150 Covered Price = $3.56 Covered Value = 1,150 x $3.56 = $4,094 Profit = $4,946 - $4,094 = $852 Final Capital = $4,946 + $852 = $5,798 $3.56 1, ,630 Short Value = 1,630 x $3.56 = $5,802 Covered shares = 1,630 Covered Price = $2.85 Covered Value = 1,639 x $2.85 = $4,645 Profit = $5,798 - $4,645 = $1,153 Final Capital = $5,798 + $1,153 = $6,951 $2.85 1, ,440 Short Value = 2,440 x $2.85 = $6,954 Covered shares = 2,440 Covered Price = $2.28 Covered Value = 2,440 x $2.28 = $5,563 Profit = $6,951 - $5,563 = $1,388 Final Capital = $6,951 + $1,388 = $8,339 Total Short quantity

112 111 Price in $ Beginning Shorted Shares Additional Short Quantity Total Short quantity $2.28 2,440 1,220 3,660 Short Value = 3,660 x $2.28 = $8,345 Covered shares = 3,660 Covered Price = $1.82 Covered Value = x $1.82 = $6,661 Profit = $8,339 - $6,661 = $1,678 Final Capital = $8,339 + $1,678 = $10,017 $1.82 3,660 1,840 5,500 Short Value = 5,550 x $1.82 = $10,010 Covered shares = 5,550 Covered Price = $1.46 Covered Value = 5,550 x $1.46 = $8,030 Profit = $10,017 - $8,030 = $1,987 Final Capital = $10,017 + $1,987 = $12,004 $1.46 5,500 2,750 8,250 Short Value = 8,250 x $1.46 = $12,045 Covered shares = 8,250 Covered Price = $1.16 Covered Value = 8,250 x $1.16 = $9,570 Profit = $12,004 - $9,570 = $2,434 Final Capital = $12,004 + $2,434 = $14,438 Net Profit = $14,438 - $1,700 = $12,738 on a $1,700 investment

113 112 VXX Price in $ Beginning Shorted Shares Additional Short Quantity $ Short Value = 100 x $47 = $4,700 Covered shares = 100 Covered Price = $42 Covered Value = 100 x $42 = $4,200 Profit = $4,700 - $4,200 = 500 Final Capital = $4,700 + $500 = $5,200 $ Short Value = 123 x $42 = $5,250 Covered shares = 125 Covered Price = $38 Covered Value = 125 x $38 = $4,750 Profit = $5,250 - $4,750 = $500 Final Capital = $5,200 + $500 = $5,700 $ Short Value = 175 x $38 = $6,650 Covered shares = 175 Covered Price = $34 Covered Value = 175 x $34 = $5,950 Profit = $6,650 - $5,950 = $700 Final Capital = $5,700 + $700 = $6,400 $ Short Value = 250 x $34 = $8,500 Covered shares = 250 Covered Price = $31 Covered Value = 250 x $31 = $7,750 Profit = $2,939 - $2,370 = $750 Final Capital = $6,400 + $750 = $7,150 Total Short quantity

114 113 Price in $ Beginning Shorted Shares Additional Short Quantity $ Short Value = 350 x $31 = $10,850 Covered shares = 350 Covered Price = $28 Covered Value = 350 x $28 = $9,800 Profit = $10,850 - $9,800 = $1,050 Final Capital = $7,150 + $1,050 = $8,200 $ Short Value = 475 x $28 = $13,300 Covered shares = 475 Covered Price = $25 Covered Value = 475 x $25 = $11,875 Profit = $13,300 - $11,875 = $1,425 Final Capital = $8,200 + $1,425 = $9,625 $ Short Value = 625 x $25 = $15,625 Covered shares = 625 Covered Price = $22.5 Covered Value = 625 x $22.5 = $14,062 Profit = $15,625 - $14,062 = $1,563 Final Capital = $9,625 + $1,563 = $11,188 $ Short Value = 800 x $22.5 = $18,000 Covered shares = 800 Covered Price = $20.25 Covered Value = 800 x $20.25 = $16,200 Profit = $18,000 - $16,200 = $1,800 Final Capital = $11,188 + $1,800 = $12,988 Total Short quantity

115 114 Price in $ Beginning Shorted Shares Additional Short Quantity Total Short quantity $ Short Value = 1,000 x $20.25 = $20,250 Covered shares = 1,000 Covered Price = $18.20 Covered Value = 1,00 x $18.20 = $18,200 Profit = $20,250 - $18,200 = $2,050 Final Capital = $12,988 + $2,050 = $15,038 $ , ,225 Short Value = 1,225 x $18.20 = $22,295 Covered shares = 1,225 Covered Price = $16.40 Covered Value = 1,225 x $16.40 = $20,090 Profit = $22,295 - $20,090 = $2,205 Final Capital = $15,038 + $2,205 = $17,243 $ , ,475 Short Value = 1,475 x $16.40 = $24,190 Covered shares = 1,475 Covered Price = $14.75 Covered Value = 1,475 x $14.75 = $21,756 Profit = $24,190 - $21,756 = $2,434 Final Capital = $17,243 + $2,434 = $19,677 $ , ,750 Short Value = 1,750 x $14.75 = $25,812 Covered shares = 1,750 Covered Price = $13.25 Covered Value = 1,750 x $13.25 = $23,187 Profit = $25,812 - $23,187 = $2,625 Final Capital = $19,677 + $2,625 = $22,302 Net Profit = $22,302 - $4,700 = $17,602 on a $4,700 investment

116 115 Disclosure: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. As an investor, you are fully responsible for any investment decision that you make.

117 116 Chapter 14 Cashing Out 1% of Your Portfolio Monthly The main idea of an investment is to make sure that the paper profits become realized profits. It is common to see people make large gains and then watch those gains disappear shortly after. We want to prevent this and have our account upward in value. Considering this, you should have a system where you cash out 1% of your portfolio value every month. Instruct your brokerage that you would like to have 1% of your portfolio sent to you as a check or wire from your trading account back to your checking account on a recurring date. Remember, in our system, you are supposed to keep 50% cash in your account because of the nature of the volatility based ETFs/ETNs. Withdrawing 1% of your portfolio will not make any difference to how you do your swing trade or your core & additional short activities. 1% a month withdrawal comes to 12% a year. The various strategies mentioned in earlier chapters give you much more than 12% ROI for the whole year. If you have a $250K portfolio, you take out $ 2,500 every month. If you have a $ 100K portfolio, you take out $ 1,000 every month If you have a $ 25K portfolio, you take out $ 250 every month. Spend this money on something that will bring you wellbeing or add value to someone else s life such as travel, your child s college fund or gifts for yourself and others. If you ever need

118 117 help deciding what to spend your money on, feel free to send us a list with your top 5 choices and we will give you our opinion. Taxes One of the main advantages of the 20% core short strategy is, you won t need to pay taxes until you cover the short position. So, if you hold short for 5 years, you can add up gains without adding up yearly taxes. The profits from the 30% swing trade profits will of course be taxed. It would be wise to discuss and create a system with a tax professional as to how to set money aside for taxes. One suggestion would be to withdraw money twice per year for taxes. This suggestion may or may not work for you, as some might feel more comfortable keeping the money in the account until year-end. That will allow for bigger position sizes amongst the groups. Disclosure: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. As an investor, you are fully responsible for any investment decision that you make.

119 118 Chapter 15 Managing Risk When M1 Is Lower Than M2 I decided to trade volatility simply because it follows a science and a logic. The logic is simple as explained earlier in this book that the price of the volatility based ETPs depend on the current month VIX futures as well as next month VIX futures. Note however that VIX futures are traded for the current month and the next seven months. If you go to vixcentral.com, you can see the VIX futures graph. The slope will help indicate how safe it is to short volatility. Looking from left to right, the VIX futures graph might have a rising slope or a falling slope. Your risk management efforts are different in both the cases. Looking from left to right, the VIX future graph might have a rising slope Look at vixcentral.com at least twice every day. If you find the VIX futures graph similar to the figure above (meaning when

120 119 seen from left to right, it has a rising slope), you can safely assume that your strategy of being short volatility will continue to work successfully. This is based on the science, math and the logic of how these VIX based products have been designed. Past analysis of the prices of these ETFS/ETNs and the VIX futures graph also confirms this fact. Irrespective of what fear mongering posts you read on publications like zerohedge.com or comments posted by volatility longs in financial social media sites like stocktwits.com, the price of UVXY, TVIX and VXX will fall, and the price of SVXY and XIV will rise as long as the VIX futures graph has an upward rising slope. This does not mean that we won t see price spikes for UVXY, VXX & TVIX. Sure, we will see such price spikes which are a result of M1 and/or M2 moving higher than the previous day s value. But if the VIX futures graph has an upward slope, the price of UVXY, TVIX and VXX will continue to fall since these funds are selling cheaper M1 to buy a more expensive M2. Risk Management During Periods When VIX futures Have Rising Slope Still, you need to have sound risk management in place. Below is a list of things you should pay special attention to: Stick to plan. In no circumstances should the cash balance in your portfolio go below 50%. Try to use your 30% portfolio amount for swing trades, but as soon as you notice profits on your trades meeting your ROI expectation, close the swing trades and realize profits. This way, not only are you adding profit to your

121 120 account, you are also ensuring that this 30% portfolio (all of it or some of it which has been closed) has returned back to cash. Thus, in the rule, your aim is to turn into an 80% cash portfolio by a few clicks of the button. With this, if you are holding 20% of your portfolio in volatility shorts, you can deal with any volatility storm that comes your way rather easily. Do not keep a target that your 30% swing trade should result in a daily profit of $500 or $1,000 or any specific amount. There might be days when there are no trading opportunities. By entering in trades on days like this, you are only increasing your risk. Don t trade just for the sake of trading. You can minimize risk and maximize ROI by entering in trades just after a huge volatility peak has ended and volatility has started coming down. Your aim should be to be all in (for the 30% swing trade component), to ensure that you enter at the most opportune time. Needless to say, as volatility continues to fall, you should start taking profits slowly on some of the swing trades. Never ever go long on volatility. 50% cash (plus 30% swing trade amount which is available to you on a button click) is your hedge. With a possible 80% portfolio value available as cash, you do not need to buy VXX/UVXY calls for hedging purposes. Try to utilize your swing trade opportunities, (if you have time for trading) to add profits to your account. This will make your account healthy.

122 121 Negotiate with your brokerage and get a better commission and fee structure. If you are doing hundreds of trades, the money saved on commission is money earned. If you are trading SVXY & XIV for a swing trade, buy and sell at the best possible prices using limit orders. Make use of pre-market and after-hours to close out profitable trades for your swing trade components. Don't be greedy waiting to have more profits the next day. Tomorrow is a new day, and you could very well see another opportunity to enter a new trade. In your 30% Swing Trade component, have a mix of all the 5 tickers - VXX, TVIX and UVXY for shorts and SVXY and XIV for longs. This mix of unleveraged and 2x leveraged ETFs/ETNs will not only give you good ROI, but will balance your risk as well. Don t be greedy for profits in your 30% Swing Trade. If you are closer to your ROI and you see a chance to close the trade, make profit and free up cash, do it. If you are shorting VXX, TVIX or UVXY, sell at the best possible prices using limit orders. If you are shorting and UVXY and VXX rise due to a volatility spike, don t rush. Have a plan that you will short in layers. First at a 5% price rise, then at a 10% price rise, then at a 15% price rise. This way, you can ensure that you are minimizing your risk.

123 122 Reserve your shares to short (for VXX, TVIX and UVXY) by entering orders in the pre-market hours at prices which cannot be fulfilled easily. This way, you are ensuring the availability of shares to short during the day. You can always change the order during the day. Never use your margin. Remember, your brokerage gives you margin money which is like a loan. Our guiding principle is to keep 50% cash and whenever possible, turn the 30% swing trade component into cash. So, in this system, there would be no possibility of utilizing your margin. This would minimize your risk to a great degree. When buying SVXY calls, never buy out of the money calls. You stand to lose the whole money invested in that trade. When buying deep in the money SVXY calls, only buy the amount of which you can take delivery. Assuming SVXY s price is $85, you go for only 1 SVXY deep in the money call if your account can only permit $8500 towards buying the 100 shares in case that the option is exercised. If you are selling SVXY naked puts (a bullish option), only do it when there is a huge volatility spike which has resulted in a big SVXY price drop. Again, sell the "at the money" put 1 month down the line. In a non-volatile market, if at all you are selling SVXY in the money weekly / monthly naked puts, only sell as many which your account can absorb, if these options are exercised.

124 123 When buying VXX / UVXY puts, never go for puts expiring less than 2 months away. Always go for "deep in the money" puts 3 months down the line. Also, to reduce risk, buy these puts only when the volatility spike has ended (this is when you will pay the least for these puts). Note that while "at the money" long dated puts have worked most of the times, they do pose a risk if we see repeated volatility spikes and falls lasting over a month. To reduce your risk, avoid buying "at the money" long dated puts. There is no need to buy VXX / UVXY puts if you don t see an opportunity. If at all you are selling UVXY and VXX calls, always sell out of the money naked calls (for maximum strike price) 2 to 3 months away. This will have the least risk and maximum chances of success. When profitable, close the trades because the same naked call can be sold again when the volatility rises. If you are selling a weekly "at the money" or "deep in the money" UVXY / VXX naked call, do it only when you want the shorts assigned to you. Ensure that you control the number of calls that you sell which meets your 20% core short objective. Don t sell such weekly naked calls for your 30% swing trade component. For the swing trade component, you can sell at the money calls - 2 to 3 months down the line. But here also, you need to be very mindful of your position sizing so that you are managing your risk properly. I often say that any day is a good day to short VXX, TVIX & UVXY. It might not be the smartest play. If you short

125 124 on price spikes and use that short for the 20% core, it will go a long way in strengthening your account. As long as the VIX futures have a rising slope, never ever close your 20% portfolio shorts. This is where you are using the components of time and compounding to earn double digit or triple digit return on investment. Don't ever exceed more than 20% of portfolio for core shorts. If you are 9-to-12 months since your started your core short - you will notice that your account profitability would have risen by a considerable amount. Pay special attention to how many short shares you have, and ensure that you still have 50% portfolio as cash and 30% swing trade value in the account. Finally, we have nothing against stocks like AAPL, FB, GOOGL and NFLX. But if you invest in these, your luck depends on their earnings, analyst ratings and what appears in the press. In volatility, you just have to keep an eye on the VIX futures graph. Disclosure: This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. As an investor, you are fully responsible for any investment decision that you make.

126 125

127 126 Chapter 16 Managing Risk When M1 Is Higher Than M2 Things get really interesting when the VIX futures graph changes from an upward rising slope to a downward falling slope. Below is the VIX futures graph for August 19, Everything looks fine as the VIX futures graph is rising upwards when we look from left to right. The next day, August 20, 2015, we see something odd happening as M1 is equal to M2 while previous days M1 was less than M2. Be mindful of such early warning signs.

128 127 On August 21, 2015, the VIX futures graph starts taking a different shape where the M1 to M4 has a downward slope. This means that every day, VXX, UVXY & TVIX will sell an expensive M1 and buy a cheaper M2. Obviously if this VIX futures graph was to continue for next 4 months, instead of the price falling for these Volatility ETNs / ETFs, we will see their price rise.

129 128 And if the VIX futures graph has a full downward slope, as is shown in the below chart, we need to reevaluate our volatility strategy. Looking from left to right, the VIX future graph has falling slope When we encounter such a situation, we have 3 choices a) Cash Out completely from the short volatility position and wait it out for normalcy to return b) Cash out 50% and then continue to be in the short volatility trade c) Cash out completely from the short volatility trade and enter the long volatility trade Let us discuss each of these choices in a little more detail.