How to Profit from Market Volatility

Asad Dossani

Last week, the India VIX witnessed a huge jump. And so far, it has held up. By long-term historical standards, the VIX remains low. But by short-term historical standards, the VIX is fairly high. And this is good news for those looking to profit from market volatility.

First, let's define market volatility. Volatility is all about the magnitude of the move, irrespective of direction. When we trade volatility, we are trading the size of the move. We don't care about direction. This is a new concept for most traders used to predicting whether the market will go up or down.

But predicting volatility has one major advantage: It's a lot easier to predict than direction. Why is that? First, we know that predicting market direction in the short term is tough. Even the best trading systems will work only 60% of the time. Further, news can move the market in a direction we didn't expect. Now, in the long term, direction is easier to predict, especially for stocks. But on a day-to-day basis, that's not the case.

Volatility too isn't completely predictable. But it's easier to predict. This is because volatility is mean reverting. This means that it tends to fluctuate around some mean or average value in the long run. If volatility is temporarily high, then it's likely to fall over time. Vice versa if volatility is temporarily low.

Usually, volatility is related to news. During times of panic or crisis, there's a lot of news. And so the market is highly volatile. But we know this can't last forever. At some point, things calm down. And when they do, volatility goes down.

On the other hand, there are times when there is hardly any bad news. The last few months have been like that. And as a result, volatility has been low. But this too doesn't last. At some point, there will be bad news. This has occurred over the last two weeks. And when it occurs, volatility goes up.

Hopefully you can see that volatility can't stay too low or too high for long. It reverts to its mean. And this creates trading opportunities. You can buy volatility when its low, or sell it when its high. And when the mean reversion occurs, you'll make a profit.

How exactly do you trade volatility? By using options. Next week, I'll show you exactly how to do this. You can also learn more in our latest learning course Derivantage. It teaches you exactly how to use options to profit from market volatility.


Market Notes

Telecom Sector: Out of the Woods?

We have seen a lot of drama in the Indian telecom sector in the past one year - most of it because of Reliance Jio's entry into the space. Competition intensified and the sector moved towards consolidation. There was a lot of merger activity. Idea cellular and Vodafone was the biggest merge with Bharti Airtel-Telenor, Reliance Communication (Rcom)-Aircel, MTNL-BSNL also among important mergers.

The earnings of the telecom incumbents slowed quarter on quarter. Their combined debt levels also increased. But the real damage came from the pricing war among the telecom operators to keep up with Jio's industry-shaking offers.

So the storm hit and damage was done. But could a telecom sector revival be around the corner?

The Jio-effect is waning and things seem to be going back to normal. Reliance Jio will have to slowly raise tariffs and end the promotional offers by the end of this fiscal. This might help incumbents recover a bit. And it seems that might have already started.

Have a look at the chart below. The telecom incumbents have outperformed the broader market indices year-to-date. Although Idea Cellular just managed to beat the index, Bharti Airtel, the telecom market leader, outperformed the index by a huge margin. It's gained 37% year-to-date whereas the Nifty Index is up only 21%.

Telecom Incumbents vs the Nifty Index
 Cutting Losses Short in Bosch

Last time we reviewed the telecom sector chart, it was trading in downtrend tracking the descending trendline. The price action wasn't encouraging at that time. But we said if the index could break above the falling trendline and challenge the high of Rs 1,434 made in January 2016, it might see some strength.

As a matter of fact, the index did break above of this descending trendline to end its year and a half downtrend in May 2017. Thereafter, the index rallied strongly in an uptrend to overtake its January 2016 high of 1,434. It made a new life-time high of 1,488 last month.

S&P BSE Telecom Index in an Uptrend
 Cutting Losses Short in Bosch

Although the telecom index corrected a bit after hitting a new life high, indices or stocks in general usually tend to outperform after hitting a new life-high. So it looks like the telecom sector could be out of the woods.

The price action seems to be indicating this could be the end of the severe competition. If the index continues to trade with the current momentum, a number of opportunities could lie ahead for us. Digging a bit deeper into the telecom stocks could help you lock your next big winner.

From The Market Wizards...

'The most important rule of trading is to play great defense, not great offense.' - Paul Tudor Jones

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