One Way to Play the Coming Interest Rate Storm
To continue on the theme of an interest rate shock, I thought I would put out an idea of how to make money from this scary scenario. It seems to me we have a plethora of negative trends in the world that could lead to a perfect storm of market stress. The global debt crisis, currency wars, the anemic economies of the West suffocating under big government policies, conflagration in the Middle East, global Jihad, the rise of China, Putin dreaming of another Russian superpower, et cetera, et cetera, all loom over the horizon. You notice I haven’t mentioned the most direct threat to calm markets of all, the tapering of quantitative easing by the Federal Reserve.
It’s always difficult to find a way to effectively short a U.S. Treasury instrument. Since you can’t directly short the security, typically investors look for a proxy that creates the same payoff if the investor is right and bond prices plummet. The problem I see is that rapidly rising rates will affect not just the bond market but the equity, real estate, and possibly FX markets as well. In short, the coming market stress will not be selective, everything will get hit. So I suggest another option (pardon the pun), to profit from the crisis: Derivatives on the VIX.
Although not always perfect, the Volatility Index has historically been a good proxy for market stress. The trick is knowing when to put a trade on; the index does not always move directly with other market fluctuations. Technically, the VIX is a measure of implied volatility in the S&P 500. The absolute level of trading suggests a similar percentage move to come in the equity index. The key word here is implied. The VIX looks to volatility in the future.
In short, derivatives on the VIX are a great way to capture and monetize market stress. It’s not nicknamed the ‘fear gauge’ for nothing. So, back to the trade.
I have found over the years that when the VIX drops below 14, things get interesting. Typically, if you put on a trade at or below this level and the market corrects, the index rises and you make money. With all of the recent talk of tapering from Bernanke, the index moved above 20 and has settled around 16.5.
I would be patient and wait for an opportunity to buy at or slightly out of the money calls. The month you buy depends on how aggressive you want to be. When interest rates rise and the equity market declines, you’ll be in the money.
Born in Georgia and raised in Savannah, Todd spent his early summers in Carp Lake, Michigan listening to the vivid stories of his grandparents recalling their youth in the northern wilderness. Ever since his earliest days, he loved story telling.
Todd left Savannah in 1982 to attend the U.S. Air Force Academy in Colorado Springs, CO where he studied aeronautical engineering. Upon graduation in 1986, he immediately left the Academy for flight school. His initial assignment was flying Combat Search and Rescue helicopters at Elmendorf Air Force Base in Anchorage, Alaska. In the UHAE (Unique Harsh Arctic Environment-pronounced “Yoo Hay” by Alaskans) he flew local rescue missions and was also deployed throughout Asia. During this time he was credited with saving many lives and even more assists. In addition to flying exciting missions, Todd also managed to graduate from the University of Alaska Anchorage with an M.S. in Engineering Management. In 1990 he volunteered for Special Operations and went back to flight school. In 1991 he was assigned to the 20th Special Operations Squadron at Hurlburt Field, FL, flying MH-53J Pave Low helicopters. Immediately he was deployed to Kuwait. Over the next three years he was active in classified missions in support of counterterrorism under the control of the National Command Authority and deployed throughout the world. His customers included SEAL Team Six and Delta Force. He left the Air Force as a Captain in 1994. During this hectic period in his life he found time to write his first novel, The Ultimate Solution which was never published. He did publish an article in the Armed Force’s Journal in 1994 on Special Operations Aviation.
1994 found Todd joining an investment bank and earning a chance to expand his knowledge of his other passion, Finance. During this second career he became highly knowledgeable in Emerging Markets Fixed Income and traveled a great deal internationally with a focus on the Caribbean. He has conducted business in over forty different countries. He became acutely aware of the consequences of economic decisions and their effect on national and economic security.
However, Todd.’s love of storytelling was uncontrollable. He left the financial business in 2011 to write. Currency was published in December of that year. Once he began typing, he never stopped.
Todd lives on a three-hundred year old farm in Connecticut deeded by King George of England with his children.