A Resolution to Break Volatility Addiction


Stocks lost ground today, with the DowJones Industrial Average and the broader S&P 500 declining 1.2% and 1.1%, respectively. For the S&P 500, it was the fifth consecutive daily decline, the longest such streak in three months.

Breaking the volatility addiction
In this morning's column, I noted that the VIX rose above 20 yesterday on an intraday basis yesterday for the first time since July 25. (The VIX, calculated based on S&P 500 option prices, is a measure of the market's expectations for stock volatility over the next 30 days.) Today, it gained another 16.7%, to close at 22.72 -- its highest closing value since mid-June.

That "volatility of volatility" did not go unnoticed by speculators: Two of the 25 volume leaders in U.S. equity markets today were not common shares at all, but VIX-related exchange-traded notes (ETNs). All told, trading volume in the iPath VIX Short Term Futures ETN and the VelocityShares Daily Inverse VIX Short Term ETN amounted to roughly $1.5 billion -- a staggering amount for negative-sum investment products.

Individual investors should avoid trading these and other, similar products, which serve as a hot potato that the fast-money set pass back and forth among each other, their aim being to slice off a sliver of potato before they burn their fingers. That's before even mentioning the risks associated with the design and robustness of these products. In March, the relationship between a similar ETN, the VelocityShares Daily 2x VIX ETN, and its underlying index collapsed; as a result, investors suffered a stunning 50% decline over a two-day period.

Here's a good resolution for self-confessed investors: In 2013, I resolve to observe volatility, to take advantage of it when Mr. Market offers up good quality equities at a discount to their intrinsic value, but never to trade it.

And speaking of discounts to intrinsic value: Bank of America is the best-performing Dow component in 2012, up over 100%. Despite this, the Fool's top banking sector analyst believes the shares still offer a margin of safety at current prices. To learn more about the most-talked-about bank out there, check out our in-depth company report on Bank of America. The report details Bank of America's prospects, including three reasons to buy and three reasons to sell. Just click here to get access.

The article A Resolution to Break Volatility Addiction originally appeared on Fool.com.

Alex Dumortier, CFA, has no positions in the stocks mentioned above; you can follow him on Twitter, @longrunreturns. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.