New Oil Vix Lets Investors Bet On Market's Volatility
Which way oil prices are headed is anyone's guess. But at least now you can place bets on the market's continued volatility.
This week, the Chicago Board Options Exchange introduced the Crude Oil Volatility Index, or OVX. The gauge is the energy counterpart to the CBOE's closely watched Volatility Index, which tracks fear trading in the stock market.
Investors can make money on moves in the oil market either way by buying options contracts that bet on a certain level for the index.
A typical contract will cost about $500, depending on market factors and price determinants. Traders capitalize as oil trading moves in both directions, with a 30-day contract duration.
The CBOE offers the Oil Vix as a way to capitalize on wild swings in crude prices like the ones this week, where the commodity plunged as much as $9 a barrel then halved the losses before the market close. (Track the Oil Vix here.)
"These are swings like you've never seen since the early '80s," says John Carter, president of Trade the Markets online newsletter. "It's not a a steady price trend up or down, it's just these hellacious moves. I think the thing they're doing with the CBOE is a good way to play it."
To be sure, those buying volatility options contracts can get burned in a hurry on such trades.
If buyers make a bet, or strike, that prices will continue to fluctuate and volatility lessens, they can lose their investment in no time. That's why those who counsel investors with a long time horizon advise against such trades.
"If you're talking about an individual who wants to trade their own account, looking at individual commodities and individual positions is fine," says Michael Kresh, of M.D. Kresh Financial Services in Islandia, N.Y. "But from an individual investor's standpoint you need to be taking a longer-term standpoint with broad-based exposure. I wouldn't recommend that any of my clients invest in any specific one."
Carter, too, says the risks for long-term investors is probably too great.
"I wouldn't see a lot of applications for the retail investor unless they're a little more sophisticated," he says.
But for those with a higher appetite for risk, the Oil Vix could be a valuable asset during a turbulent time.
"The question you ask yourself is, 'Are oil prices going to go higher or lower and is the price action going to calm down anytime soon, or are the moves going to get more and more whippy on a day-to-day basis?' " Carter says. "It's a way to go in there and kind of hedge any (exposure) you might have."
The Oil Vix will hold near-term futures contracts and cash to compute the level of volatility in the West Texas Intermediate crude markets, much the same way as it uses movements in the Standard & Poor's 500 in stock Vix calculations.
"If oil prices continue to be really crazy it causes the volatility to be higher and that options contract goes up," Carter says. "You could also be completely dead wrong and lose that (investment)."
The Oil Vix stood at 52.46 by 1 p.m. Wednesday, up 1.57 for the day.