The power of the VIX and UVXY

On January 24, 2022, the Dow industrials were down 1,100 points before they staged an unprecedented comeback to close 86 points higher. That kind of intraday price swing is not supposed to happen. ETFs that track broad indexes like the Dow, NASDAQ, and S&P 500 typically shield investors from extreme stock market volatility.

A twisting roller coaster to symbolize how extreme stock market volatility feels.
Photo by Niel PH on Unsplash

Those were not typical times. And neither is today.

Bank collapses, inflation, and interest rate hikes have whipsawed the markets. Since the beginning of 2023, stocks have been on a roller coaster. They crash multiple days in row and then rally. But after just a day or two — right when investors think the pullback is over — stocks plummet again.

This is called volatility. Volatility is a measure of how much an asset price moves up or down, particularly in the short term.

In general, the more volatile an asset is, the more risky it is. Small-cap stocks and cryptocurrencies are good examples. If you are a more conservative investor who hates seeing big swings in your portfolio, it’s best to avoid volatile assets.

But what do you do if the entire stock market is experiencing extreme volatility?

Is there a way to protect your portfolio — and your emotions — from these punch-you-in-the-gut price swings?

Thankfully there is. In fact, you can even profit from stock market volatility and extreme fear in the markets by trading a single ETF.

The ProShares Ultra VIX Short-Term Futures ETF (UVXY) provides leveraged exposure to the S&P 500 VIX Short-Term Futures Index. It seeks results that are 1.5 times the daily performance of that index.

Wow…that last paragraph was a mouthful of jargon.

Let’s break down what that all means. 

The VIX is Key to Profiting Off Stock Market Volatility

Before we can understand UVXY, we need to understand the Cboe Volatility Index, which is better known as the VIX. The VIX is a real-time index representing the market’s expectations of volatility over the next 30 days.

You’ll often hear the VIX referred to as the fear gauge. That’s because investors use the VIX to measure the level of risk, fear, or stress in the market.

When fear and stock market volatility are high, the VIX rises. When markets are stable, the VIX decreases. For example, when Silicon Valley Bank collapsed last week, the VIX spiked and stocks crashed.

How to Profit from the VIX with Options

Volatility and risk play an enormous role in the price and success rate of options trades. For instance, if you place a bull-call spread, you want the market to increase at a slow and steady pace. That’s because when stocks rise too fast, they often pull back just as suddenly.

Volatility can destroy your short-term trades, not to mention significantly increase option premiums. That’s why it’s important to keep your eye on the VIX. When it’s spiking, it becomes difficult and risky to trade. It can also signal that a market pullback is coming.

Since the VIX is an index, you can track it just like you would the S&P 500 or Dow Jones Industrial Average. You can even profit off it by trading options. For example, if you think that market volatility is coming soon, you could buy call options or a bull-call spread of the VIX index (VIX).

How to Profit from the VIX with Stocks

You cannot, however, buy shares of the VIX. That’s because you can’t own an index. An index is simply a tracking instrument.

Also, unlike the S&P 500, which has ETFs designed to mimic its performance (e.g. SPY), there are no VIX ETFs. The best you can do is buy an ETF that is benchmarked to an index of VIX futures contracts. That’s what UVXY does. Futures contracts allow investors to speculate on the price direction of an index, in this case, the VIX.

Black and white photo of a person standing under an umbrella in the middle of a rain storm. Symbolizes the risk hedge that UVXY can provide against stock market volatility.
Photo by Steven Su on Unsplash

UVXY is a Hedge Against Stock Market Volatility and Fear

Buying UVXY is like buying insurance. If you pick up shares when market volatility — and hence UVXY’s price — is low, you’ll have protection against a pullback.

Whenever the next market scare comes along, volatility and investor fear will increase, which will in turn cause UVXY to spike. When that happens, you’ll reap big profits. Those gains will also help offset losses from stocks or bull-call options that you hold.

Things You Need to Know before Buying UVXY

While UVXY is a great hedge against stock market volatility, it still comes with risk. These risks are also very different than typical ETFs and stocks.

First, UVXY is a leveraged ETF. It uses financial derivatives and debt to amplify the returns of its underlying index, the VIX Short-Term Futures. UVXY is leveraged at 1.5x, which means that it will produce returns that are 1.5 times that of the underlying index.

For example, if the VIX Short-Term Futures Index gains 20%, UVXY will gain 30%. Of course, this works both ways. If the underlying drops 20%, UVXY will drop 30%.

Leveraged ETFs provide the opportunity to maximize your gains, but they also multiply losses. Therefore, they are best used to take advantage of short-term market moves. They are rarely suitable for long-term investing.

As such, UVXY should only be used as a short-term trading tool. NEVER use it as part of a buy-and-hold strategy. This is because UVXY’s price decreases over time due to a phenomenon called contango. Contango is when the futures price is higher than the spot (current) price.

Moreover, funds like UVXY do not hold their futures contracts to expiration. Instead, when contracts approach expiry, they roll them. Rolling is the process by which a fund closes out a futures position prior to its expiration month and then purchases an identical futures contract with a later expiration date.

The combination of contango and rolling leads to additional fees, which negatively impact the fund’s performance. Since it is common for VIX futures to be in contango, ETFs like UVXY lose money over time.

That understandably leads to this question…

Why Would You Buy Something that is Guaranteed to Lose Money in the Long Run?!

The answer to that question goes back to what I said in the beginning: UVXY and similar ETFs are for short-term trading only…NOT as buy-and-hold strategies!

While it’s true that UVXY will lose money in the long run, the price decline is not constant. Take a look at this 3-month price chart. (Note: I created this chart in 2021 for illustrative purposes only. It is not current.)

3-month price chart showing the extreme price swings of UVXY.
Chart created by the author in Trading View in January 2021.

The price moves from the top-left corner to the bottom-right, which demonstrates a significant overall loss. But…look at all the upward spikes along the way. That is how you profit off UVXY.

Let’s say that UVXY trades at a low price, but you’re expecting stock market volatility in the near future. That could cause one of the spikes that you see in the chart. Those price jumps can be significant, often leading to 50%-100% gains in just a day or two. When that happens, you can sell your shares and lock in the profits.

A UVXY Strategy to Use Before, During, and After Stock Market Volatility

Since UVXY is usually in a steady decline, it’s best to start by opening a small position and then slowly add to it over time. When I trade UVXY, I start by committing 1% of my portfolio and then dollar-cost averaging until I’m at a maximum of 5% allocation.

This gradual accumulation of shares accomplishes two things:

  1. Even if my timing is completely wrong, I will only lose a maximum of 5% of my portfolio. And that will only occur if UVXY’s price goes to $0 (highly unlikely).
  2. Acquiring shares at decreasing prices sets me up for a huge profit when volatility spikes.

How to Continue to Profit Even After UVXY Spikes

As I mentioned above, I sell my shares of UVXY after large price jumps to lock in the profits. After that, I have two choices:

  1. Wait until stock market volatility returns to normal, which will cause UVXY to drop again.
  2. Buy puts or bear-put spreads of VIX.

Choice #1 is straightforward. I simply sell when I reach my desired profit and then wait for prices to drop. After that happens, I’ll restart the buying cycle.

But why not profit from both directions? That’s choice #2.

When I see signals that market volatility is peaking, I’ll open a VIX bear-put spread option. (Buying a put can also work, but I much prefer spreads). This strategy lets me profit when the VIX index drops.

The most challenging part of this options strategy is picking an expiration date far enough away to give time for the VIX to drop but not so far away that premiums are too high and/or the VIX spikes again.

But what about UVXY? Can you instead short that ETF?

Theoretically, you can. It’s difficult to get your ordered filled, however, because UVXY shares are hard to borrow. Your trading platform may even alert you to this.

That’s why my strategy is to buy shares of UVXY when I expect market volatility and fear to increase and to open VIX bear-put spreads when I anticipate volatility to drop. The former gives me a leveraged position without the time pressure of options. The latter is easier to get and also lets me profit when markets stabilize.

I hope this strategy helps you profit even when stocks are bouncing all over the place. For more content like this, subscribe to The Antagonist. It’s free!

Happy Trading,
Jason Milton

Disclaimer: I’m not a stockbroker or financial advisor. I cannot and do not provide personal investment advice, and The Antagonist should never be interpreted in such a way. The Antagonist is an online financial literacy resource. All materials from The Antagonist are intended for informational and educational purposes only. They are not, nor are they intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested.

My recommendations represent the actions that I plan to take or have made based on my analysis and what works for me. The information contained on this website has been prepared based on publicly available information and proprietary research. The author does not guarantee the accuracy, reliability, or completeness of the information provided in this document. All statements and expressions herein are the sole opinion of the author and are subject to change without notice. I will not be liable for any losses and damages in connection with the use of my content. Any investments that you make are your responsibility.

Investment information provided may not be appropriate for all investors and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. The Antagonist is not in the business of transacting securities trades or an investment advisor. Therefore, it is imperative that you perform your own due diligence before replicating any of my trades. Also, options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. You must read Characteristics and Risks of Standardized Options carefully before investing in options.

2 thoughts on “Stock Market Volatility and How to Profit from It”

    • I’ve often held for a month or 2, but that’s because I use stop losses instead of time as my exit signal. I also accumulate shares in very small amounts, kind of like mini-dollar cost averaging. Usually, UVXY’s downtrend is a slow drip, but the surge up is like a geyser.

      I’ll sell all my shares then unless I think volatility will continue to rise over the next few days. In that case, I’ll sell a portion on the first big jump (especially if that nets a profit on my overall position) and then sell the rest over the next couple days.


Leave a Comment

Do Not Sell or Share My Personal Information