Going Long Volatility? Be Careful
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Regular Digest readers know we expect one thing no matter what happens next...
Whether a serious bear market begins later this year as Porter has warned... or the "
In fact, as Steve has pointed out, the last Melt Up in the late 1990s saw market-leading tech stocks soar more than 200% over the last year and a half of the rally.
Yet these same stocks fell roughly 10% – similar to the sharp correction we've seen this year – on five separate occasions over that time. And along the way, the market's "fear gauge" – the CBOE Volatility Index ("VIX") spiked above 25 more than 10 times.
History is clear: Melt Up or "Melt Down," last year's historic tranquility is unlikely to return anytime soon.
But if you're betting on higher volatility today, there's something you should know...
So-called "long volatility" has suddenly become a popular trade. As the Wall Street Journal reported on Thursday...
Stock-market swings in the past week have many investors scrambling to profit from the return of turbulence after a prolonged period of tranquility...
"The new safe haven is now volatility," said Christopher Stanton, chief investment officer at California-based Sunrise Capital LLC. "It's the one thing that's pretty much guaranteed."
Mr. Stanton is among those who are buying futures contracts pegged to the VIX, a profitable bet if volatility continues to rise. In the past two weeks, both hedge funds and asset managers have been doing the same, according to data from the Commodity Futures Trading Commission.
In other words, the same folks who were making record bets against volatility earlier this year – many of whom suffered huge losses during February's "volatility panic" – have flipped sides. They're now making record bets that volatility will move higher. The following chart puts this change in perspective...
As longtime readers know, these speculative traders are known as the "dumb money" for a reason. They tend to be wrong at extremes. When they're all making the same bet – whether they're all super-bullish or super-bearish – it's a sign that the trade is "crowded" and a short-term reversal is likely.
As always, today's extreme doesn't mean the VIX can't move higher in the near term... And again, we continue to expect volatility to trend higher in the months ahead. But speculators are suddenly super bullish, which suggests the greater risk is to the downside today.
Make no mistake...
Profiting from a rising VIX is notoriously difficult under the best conditions.
Even during periods of elevated fear and volatility, the VIX doesn't remain at highs for long. It spikes and falls – often dramatically – before spiking again.
Meanwhile, the two primary ways to bet on a higher VIX – buying futures contracts directly, or buying exchange-traded funds ("ETFs") that own these futures – have a significant cost. Due to the nature of these contracts, they tend to lose value over time. This means you can actually be correct about rising volatility and still lose money if your timing is off.
Today, the odds are stacked even further against you. If you're interested in speculating on a rising VIX, be sure to keep your position sizes small and don't risk anything you can't afford to lose.
Switching gears...
You've likely heard about the controversy surrounding social media giant – and Stansberry's Investment Advisory portfolio recommendation – Facebook (FB).
In short, news broke last month that London-based data-analytics firm Cambridge Analytica had gained access to –
Last week, the news got even worse, as Facebook said the real number of users affected by the breach was closer to 87 million.
And of course, this news follows the company's admission last fall that Russian-backed operatives had exploited its site to try and influence the election as well.
Facebook shares have plunged as a result of this controversy...
The stock is down 18% from its February highs... and the company has lost nearly $100 billion in market value in the process. The big decline has left some folks wondering if the company's best days are behind it... and whether it's time to sell.
Porter and Stansberry's Investment Advisory analyst Alan Gula say the answer is clear: absolutely not. As they explained in the April issue, published last Friday...
We sell when we hit our stop or when the story changes. Neither has happened in this case. Our fundamental thesis for owning Facebook shares remains intact. And we still see the stock as a solid investment over the longer term.
In spite of the controversies surrounding Facebook, the world continues to log in. Billions of users continue to interact with each other, sharing stories, "liking" photos, and consuming content from companies, movies, musicians, and other advertisers. They're not leaving en masse. Facebook is too big of a part of their daily lives... And for most users, there's really nothing else like it.
You see, as we explained in our December 2016 recommendation, Facebook's business possesses the most powerful "network effect" we've ever seen. Its business gets better as it gets bigger. The more users who log in to Facebook and share their stories and photos, the more attractive the website is for that next user to join. And as more consumers join the site, more information is shared, and so on. And of course, the more users, the more valuable their data and eyeballs are to advertisers.
As they explained, a business like Facebook often struggles to attain 'critical mass'...
But once it does, it's incredibly hard to compete with. More from the issue...
Growth begets more growth. Momentum increases. And the winner tends to take all – or at least take most. That's what has happened with Facebook. It is the clear winner in the social networking space (at least, outside of China). With more than 2 billion monthly active users, it's many times more popular than the next largest competitor. And that makes Facebook an incredibly powerful economic engine and cash-flow machine.
Simply put, Facebook is one of the most capital-efficient companies we have ever seen. And that's even with no long-term debt and more than $41 billion of its capital base in the form of low-yielding cash...
Facebook's scale, growth, and profitability are truly in a class by themselves. And so as long as the news flow isn't so bad that a substantial number of users delete their accounts, we will want to own shares.
And fortunately, despite what you might assume given the news coverage, Porter and Alan don't believe an "exodus" is even close to occurring today...
Sure, we hear isolated anecdotes of "this advertiser leaving" or certain user groups pushing for change (including a #deletefacebook campaign that appears short-lived). And that might slow profit growth and soften user metrics, causing continued choppiness in the stock over the short term.
But the long-term capital-efficient machine is intact. So for those with a longer-term investment outlook, Facebook remains a "buy"...
While Porter and his team believe Facebook will fully recover from this controversy...
There is no denying that data breaches like this are becoming incredibly common... and increasingly costly.
"Hacking" already costs the global economy more than $450 billion a year. At its current pace, this figure could grow more than tenfold over the next decade. And no one – not even the government itself – is immune. In fact, there's virtually nothing any of us can do to fully prevent getting hacked today...
But that could soon change.
You see, several notable cybersecurity experts believe blockchain technology – yes, the same blockchain technology that powers bitcoin and other cryptocurrencies – could put an end to computer hacking and identity theft once and for all.
Even better, the Stansberry's Investment Advisory team has identified one tiny company
New 52-week highs (as of 4/6/18): none.
In today's mailbag, several new and longtime subscribers weigh in on TradeStops and volatility-adjusted position sizing. What's on your mind? Let us know at feedback@stansberryresearch.com.
"Hi... Thanks for everything you do. I'm a lifetime Alliance member and I don't believe I've ever made a better investment. Your company operates with the highest degree of integrity and the quality of your work always exceeds my expectations.
"I am also a lifetime TradeStops member. I base all my position sizes on the recommendations of that product and follow its volatility-based trailing stops... I know sometimes an analyst will recommend a stock without a trailing stop, but I'm not a professional. Without an exit strategy, I would be doomed to fail (as I have in the past). I've come to the point that investing without a trailing stop seems like driving a racing car without a seat belt. In theory, you could go faster without the extra weight, but...
"I wanted to give you feedback on some of your higher volatility recommendations. I also wanted to encourage your readers to put on their big boy pants. Follow the advice or don't. If you're reading this, you have a car and a seatbelt. The responsibility for what happens next is yours." – Paid-up subscriber Doug C.
"Porter, I started with Stansberry in 2015 with True Wealth. I became an Alliance member last summer. I have been using TradeStops for about a year, bringing the portfolio volatility down with the Risk Rebalancer in there. Also, last fall I introduced a friend to both Stansberry subscriptions and TradeStops, and he's using the same strategy. So, some of us at least are learning." – Paid-up subscriber Brandon L.
"Great article about volatility. I never understood 'beta' before. I have been guilty of taking too much risk..." – Paid-up subscriber George K.
"I have been using this service for a number of years and am very happy with it not to mention the fact that I am wealthier for doing so." – Paid-up Stansberry Alliance member Herb B.
"Read your recommendation for TradeStops. Bought a lifetime subscription a couple of years ago and follow its recommendations. Sometimes I make a small change to position sizing because I believe a business
"You asked for feedback. I am a lifetime subscriber of TradeStops. I will start today using position sizing. In fairness, I've heard you say this before. Shame on me." – Paid-up subscriber Bryan N.
"Hey Porter, from reading your article, it looks as if this qualifies as a contrarian email. I'm writing to say, not only am I going to follow your advice, I've been doing so for two years now. I've been a TradeStops Premium member, have finished my 2018 allocation adjustment and have a Portfolio VQ of 11%. Richard's tables say that anything under 15% is
"What a genius idea! Actually, I inherently do this qualitatively with my risk portfolio: I have a maximum 5% position size, then scale it according to its volatility. But honestly its loosely based on the industry and speculative nature of the option (and underlying stock). Never thought to quantitatively normalize the beta score with position size!" – Paid-up (new) subscriber James B.
"Since the vast majority of my portfolio is invested in mutual funds – this will not work for me." – Paid-up subscriber Fred B.
Brill comment: Actually, Fred, that's not correct. TradeStops currently only works with equities on foreign exchanges, including Canada, London, Germany, and Australia. But here in the U.S., Richard's service tracks stocks, funds (including mutual funds and exchange-traded funds), indexes, and options... so there's a good chance it would work for you.
Again, we'd encourage you to take advantage of Richard's generous 30-day, 100% money-back guarantee to see for yourself. You can learn more – including how you can claim a full extra year of TradeStops Premium for free – right here.
Regards,
Justin Brill
Baltimore, Maryland
April 9, 2018