When the VIX is low, as it is now, traders tend to become complacent. Instead, you should use move with caution and buy protection, because you never know what is coming down the pike.
Just look at last week’s action. The markets flirted with a total breakdown that would have pushed the bulls aside. But just as they have done since the beginning of the year, the dip buyers saved the bulls. Sure some important levels were tested and re-tested, but buyers stood firm.
The dip buyers won’t always save the day. A time will come when those buyers don’t see a reason to step up. The markets will swoon, as they did last October and December. Think back to late September 2018. The VIX was very low while the market’s internal conditions were eroding. This was an important sign that many traders missed.
How to trade when the VIX is low
Currently, I don’t see those same conditions. But when the VIX is low, it is prudent to buy put protection for your portfolio. Low volatility means option premiums are dirt cheap. Better safe than sorry, because like I said above, you never know what’s going to happen tomorrow.
The markets are overbought, and without much of a correction in 2019, there is certainly a chance we’ll get a whack. What if the dip buyers don’t materialize? They aren’t going to tell you ahead of time whether they’re in or out.
When that market downturn arrives, you will still suffer some losses, but it will be greatly minimized. Remember, it’s like buying homeowner’s or car insurance. It will save you a lot of money when you need it.
Here’s what I do:
Buy some at-the-money strikes on ETFs like SPY, DIA or QQQ and pick up some puts that are one to three weeks out. If a pullback does not occur, your portfolio of long stocks or long call options should rise and the loss from the puts should be negligible. I do this often, and while it drags down my overall performance a little, it helps me sleep better at night.