This 'Fear Trade' Could Bring You 87% GainsBy Deborah O'Malley, StreetAuthority

With a slew of bad news recently hitting the streets, it appears fear is on the rise.

Unemployment rates remain high at 8.8%, housing sales are still sluggish and, despite an already weak U.S. dollar, the Federal Reserve is expected to keep interest rates near zero -- making the currency less attractive to outside investors.

On top of all this, on April 18, one of the most recognized credit-rating agencies, Standard & Poor's, lowered its U.S. debt outlook from "stable" to "negative." The downgrade means an increased likelihood the United States could lose its coveted "AAA" credit rating within the next two years.

The outlook was lowered because S&P believes the U.S. government isn't taking aggressive-enough action to reduce its massive debt load, especially in comparison to other debt-ridden countries.

Of the 17 countries deemed by S&P to have "AAA" status, the United States is now the only one to have a negative outlook -- a trend that could very well buck.

The notion that the United States could lose its credit rating has all-around negative economic implications. For starters, it means the cost of borrowing could increase. But worse yet, the U.S. dollar could lose its status as the world's reserve currency, causing a potential economic breakdown.

Fortunately, as a trader, there are ways you can benefit from these worries. As billionaire value investing guru Warren Buffet famously said, "be fearful when others are greedy, and be greedy when others are fearful." And by all accounts, now is a great time to be greedy -- with a reliable trading instrument.

But don't just take my word for it. Look to the Volatility Index (VIX) to make the call -- one of the best ways to assess objectively market fear levels.

The Volatility Index is calculated by the Chicago Board Options Exchange. The CBOE takes into consideration a number of trading factors to determine the market's volatility level. In essence, low volatility typically indicates traders feel calm and bullish about the market. But when bad news pushes the market lower -- as is currently happening -- trader fear tends to increase, along with bearish sentiment.

To determine when market complacency and fear are at their height, fixed levels can be assigned to the Volatility Index (although these levels are historical and change from time to time). Generally, if the index is below 15, fear is relatively low. As the index rises toward 30, fear is increasing. And anything above 45 shows a strong level of fear.

After hitting a two-year low of 14.30 during the April 18 trading week, the index is currently hovering around 15-19. But the index appears as if it might rise, due to the recent S&P downgrade and other events triggering perceived economic instability.

Because the VIX cannot be directly traded, one way to profit from rising fear levels is to play the iPath S&P 500 VIX Mid-Term Futures ETN (VXZ).

This ETN (exchange-traded note) targets mid-term four-, five-, six- and seven-month VIX futures contracts and appears to closely mirror the activity of the VIX. So when the VIX rises, so does VXZ, and when the VIX falls, so does VXZ.

VXZ currently trades for about $53.50 and carries an expense ratio 0.89%. The security has a market cap of about $5.6 million.

Technically, VXZ appears to be on the rise.

The index peaked at $104.32 in May 2010, following the "Flash Crash," which caused volatility and fear levels to spike.

As 2010 progressed into what many perceived as a bull market, fear subsided, causing the security to steadily drop to a two-year low of $51.61 in early February 2011.

Touching support near this level, the security quickly rose to a height of $65.04 in early March, as tensions in the Middle East escalated, causing fear to rise.

Testing a shelf of resistance near $65, the security fell to around the $55 as traders tuned away from the Middle Eastern conflict.

However, during the April 18 trading week, on news of the S&P rating downgrade, VXZ jumped once again -- this time breaking resistance marked by the Intermediate downtrend line. The break of this trendline is significant, as it suggests the security could once again be on the rise.

VXN has pulled back during this April 25 trading week. But if the security again tests and breaks the trendline, it could very well move to nearby resistance at $60.05. If VXN were to test and break nearby resistance at $60.05, the security could easily soar to around $75 before encountering any substantial historical resistance.

The major downtrend line currently intersects at this level. Should VXZ break the Major downtrend line, the security could rocket to the $100-range -- a level it hit nearly a year ago.

If the security were to once again reach the $100-range, traders tuning in at current levels could make a hefty profit.

Action to Take:
Recent economic events, especially the S&P rating downgrade, appear to be reigniting fear. The VXZ security provides a great instrument to potentially profit from rising fear levels. The recent pullback provides an attractive entry point. Traders taking a position now could potentially make returns of up to 87%.

Disclosure: Neither Deborah O'Malley nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

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Major Fraud Alert

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May 29 2011 at 12:05 AM Report abuse rate up rate down Reply

Funny - when I watch the Nightly Business Report, I see very good economic and financial reports coming forward.
All sections of the country seeing economic gains (reported just last week)
Unemployment down from 10 to 8.8
Manufacturing gains for 20 months
Export gains for 20 months
Demand for machinery and equipment way up due to the 100% write offs for improvements made in this country passed by dems.
Retail sales up
New construction permits up

I suggest you try watching the Nightly Business Report on public television. They report every day, week, and month on economic gains and where and why they are occurring.

And those ground breaking ceremonies Obama attended - they're now hiring at $12 to $18 an hour - but he was just campaigning.
The new South America trade agreement will also create jobs here, just like the new $45 billion in trade with China - but he was just vacationing.

April 28 2011 at 10:35 AM Report abuse rate up rate down Reply
1 reply to inasctg56's comment

And who is fighting for ever more corporate tax cuts, fighting to cut medicare, and fighting against job creation? The gop.
Who is fighting for $400 billion in cuts to defense, going after so called offshore corportate accounts, eliminating the upper 2% tax cuts, eliminating tax loopholes, and fighting for medicare and job creation? The democrats.

So who's representing you?

April 28 2011 at 10:26 AM Report abuse +1 rate up rate down Reply

Sleep with one eye open if you own IBM stock !

IBM imprisoned Sr VP Robert ("Blabber Mouth") Moffat is forced to give a deposition in the IBM PONZI RICO Trial soon after he leaves prison !!!

Galleon brought down IBM Sr VP Robert ("Blabber Mouth") Moffat and sent him to prison. But Blabber Mouth's real problems may just be starting ! The Federal Judge has OK'd the IBM PONZI RICO trial, and Blabber Mouth's name is all over it !

Details and links --

TWITTER -- (IBM Widow)

April 27 2011 at 12:13 PM Report abuse +1 rate up rate down Reply

all those wall street crooks should go to JAIL!

April 27 2011 at 11:15 AM Report abuse +1 rate up rate down Reply
1 reply to captmerit's comment

And they are still being prosecuted as well as mortgage brokers.

April 28 2011 at 10:21 AM Report abuse +1 rate up rate down Reply

Watch the Nightly Business Report on public television or go to their web page - financial and economic reports have been positive day after day, week after week, month after month.

April 27 2011 at 9:43 AM Report abuse +1 rate up rate down Reply
1 reply to inasctg56's comment

What has President President Obama and Democrats done?
* 1.8 million job creation
* 20 months of manufacturing gains
* 20 months of export gains
* Retail sales up
* New construction permits – up 11%
* Demand for machinery and equipment way up from 100% write offs for improvements made in this country
* Trade deficit actually has seen a decline
* Illegal Immigration: Passed legislation holding businesses accountable for hiring illegals – no job, go home.
* Dow has gone from 6500 to 12,600
* IRS given resources to go after offshore accounts with over 14,000 coming forward
* Eliminated incentives for corporations to go overseas
* Eliminated 2004 gop for overseas profits to be taxed at 5%
* Passed legislation that addresses the problems of the 2002 gop banking legislation that allowed predatory lending and less oversite on wallstreet, banks, and mortgage companies
* And those ground break ceremonies he attended – now hiring at $12 to $18 an hour (but he was just campaigning)
* In 2007 dems took money away from big oil and steered it toward our auto industry for R&D with mandates for better mileage and now low and behold we have suv's that get 32 mpg as well as waiting lists for chevy volts and almost all auto workers have returned to work
* Electric batteries, charging stations, and wind turbines slated overseas under Bush are being built here now
* National debt – President Obama directed the secretary of defense to come up with wasteful spending in defense because this is a huge part of the budget and doubled under Bush. The secretary of defense reported this to congress in January. How much did Boehner and the gop cut from defense? $3 billion. Ryan’s budget? Zero. Obama? $400 billion over 12 years.

And now the gop governor of Maine is changing child labor laws so they too can work longer for less. Every day it’s another attack on working families from the gop.

April 27 2011 at 9:39 AM Report abuse -1 rate up rate down Reply
Harry Piels

The U.S. imports poverty, exports jobs, and is so stupid many states dump on abortion rights . In a "free" country, this clearly should be a private, religious decision, not a government function. "Stupid is as stupid does" F. Gump

April 27 2011 at 8:16 AM Report abuse +5 rate up rate down Reply
1 reply to Harry Piels's comment

Our manufacturing and exports have seen 20 months of gains. Why? Because we have an administration negotiating trade for american workers - not for corporations to make record profits overseas. Eliminated legislation that gave incentives for corporations to go overseas and eliminated the 5% tax rate on those overseas profits. And the new $45 billion trade with China hasn't kicked in yet as well as South Korea and South America. This is also why we have seen 1.8 million jobs the last 13 months. For every 10% gain in exports we get a 7% job gain.

April 27 2011 at 9:42 AM Report abuse rate up rate down Reply

USA is creating a huge problem............................poor people !

Debt will inflate and make help to poor impossible........................very sad story !

History will judge this as a failure of information management and knowledge by Pols !

Obama is the worst President in Modern Era since he has sponsored this Debt Boom along
with Nancy and Harry !

Wealth only is created thru Private Investment and Jobs.......................not taxing the successful !

Where is Bill Clinton when you need him ?

April 27 2011 at 7:30 AM Report abuse +4 rate up rate down Reply