A ‘Simple Hedge’ as Market ‘Bumps it’s Head’

The S&P 500 has “bumped its head” in a clear resistance level.  The VIX Index has dropped into a familiar support level.  Is the party over?  I hope not.  I would love to see the stock market keep heading higher.  But hey, warning signs are warning signs right?
So should we all panic?  Not necessarily.  Still – and fortunately – there is a difference between “being panicked” and “being prepared”.  So let’s talk about a simple hedge “just in case” the stock market decides to sell off in the not too distant future.
Figure 1 displays ticker SPY with a fairly obvious resistance range highlighted. As the verbiage on the chart asks, “will you be surprised if the market pauses or worse here?”1
Figure 1 – Ticker SPY at in resistance zone (Courtesy AIQ TradingExpert)
Figure 2 displays ticker VXX (the ETF that ostensibly tracks the VIX Index).  From a completely and entirely subjective point of view it can be argued that the VIX is in “the calm before the storm” mode.2
Figure 2 – Ticker VXX at support zone (Courtesy AIQ TradingExpert)
Figure 3 displays that the implied volatility for options on ticker VXX has fallen significantly and that VXX options are relatively cheap.3Figure 3 – VXX option implied volatility has fallen hard (Courtesy www.OptionsAnalysis.com)
So what about buying the June VXX 16 call for $200 as a hedge against the stock market suffering a hit between now and June option expiration?
Figure 4 displays the particulars and Figure 5 displays the risk curves.4Figure 4 – VXX June 16 call (Courtesy www.OptionsAnalysis.com)5Figure 5 – Risk curves for VXX June 16 call (Courtesy www.OptionsAnalysis.com)
As always I am not “recommending” this trade I am simply pointing out that several factors (S&P at resistance, VIX at support, option premiums relatively low, and don’t forget “Sell in May” which is just around the corner) may be coming together to make considering a hedge a reasonable idea.
The questions to ask yourself are:
*Do I think there is a chance/likelihood that the S&P will suffer a selloff in the next 7 weeks or so?
*Am I willing to risk $200 if it doesn’t?
Jay Kaeppel
Chief Market Analyst at JayOnTheMarkets.com and TradingExpert Pro client

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