Companies: GSK   

I thought it timely to take another look at the ‘VIX’ - a weighted measure of the implied volatility of eight S&P 100 at-the-money put and call options introduced in 1993 by the Chicago Board of Trade – and how we can profit by buying or selling volatility. While I will focus on the VIX based on the S&P 500, remember that the S&P 500 still affects European markets greatly, so even if you are not trading US markets, the VIX is worth watching.

Over the past decade, the VIX has been expanded to the broader-based S&P 500 futures index, allowing for a more accurate gauge of future market volatility. A VIX level above 30 is associated with a high amount of volatility due to investor uncertainty. Traders buy put options when they are scared and think markets will fall. Meanwhile, VIX values below 19 usually reflect low investor fear.

Traders who wish to speculate on market volatility may want to consider taking a position in CBOE volatility index (VIX) futures. IG Index offers a spread bet on this market and it’s fairly easy to trade.

For example: April volatility is trading at 24.55/24.80. If I think volatility is going up and I buy £1,000 a point at 24.80, then a few days later the quote is 27.80/28.50 and I sell at 27.80, then I have made three points times £1,000. The minimum bet size is £50 a point, which is a small bet.

So far in 2008 we have had two major VIX highs, one on 22 February, where the VIX hit 37.57, and one on 17 March, where it reached 35.60. Putting it politely, this meant traders were very scared. It means the price of options became very expensive. If you look back, you will find that these climaxes of fear points coincide with good buying opportunities, as markets tend to move higher in the following few days and volatility after blowing off comes back down again.

As a point of reference, the VIX hit 41 after the terrorist attacks of 11 September 2001 as markets were extremely nervous. However, just a few days afterwards, markets rebounded and the VIX fell.

So the way to profit is to wait for extreme fear levels such as 35+ and short the VIX, or buy the S&P 500, then you would look to cover at around 22. I have done better selling high volatility than buying low volatility, as low volatility can carry on for longer. I would mark 16 to 18 as a buying point – if we get down to this calmer reading in the next few months, think about buying volatility and look to cut back on long trades. For free charts of the VIX, go to www.stockcharts.com and use $VIX.

Seasonal factors
Over the past few years, April, May and June have seen lower volatility readings, then July, August and September have seen spikes back up again, followed by lower readings as we head towards the year-end.

Another way to sell volatility with low risk is using fixed-odds bets such as those www.betonmarkets.net offers. You can use ‘no touch’ bets or ‘bull’ bets on the S&P 500.

Bet on Glaxo
GlaxoSmithKline (GSK), the fourth-largest company in the FTSE 100 by market cap, hardly needs an introduction. For the past few years, this share has been out of favour with investors.

The shares have halved since a 1999 peak when they were trading north of £20. Warren Buffett recently took a small stake in GSK, having obviously seen the value in buying a world-leading pharmaceutical company trading on a price-to-earnings ratio of 11 and offering a 4.6 per cent yield.

I don’t see GSK going much below £10 a share, and the recent move up to £11 is the start of a new up trend. I can see £13.50 plus before December 2008. The best way to play this is with an SG Warrant.

Buy the £11 Dec 2008 call which expiries 19/12/08 (SV27).
These are currently trading at 17p and, based on a £13.50 price in November, they would be trading at 26p, giving a 51 per cent return. You could also look at the December 2008 spread bet on Glaxo and have a stop at around £9.50.

Vince Stanzione has produced a home-study course to teach private investors how to benefit from trading financial spread bets and fixed odds, priced at £347. For more details, visit www.fintrader.net or call 01189 476630.

GlaxoSmithKline	LSE	£57261.99m	1101.50p	-18.50p
Click here for interactive charting
Other company articles:
Spread Betting			28/04/2008
Diabetes drug setback for GSK			29/05/2007
Collaborations boost			05/05/2004