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High Risk Reward Trading Strategy in VIX Put Options

Stock-Markets / Options & Warrants Aug 12, 2011 - 07:52 AM GMT

By: Money_Morning

Stock-Markets

Keith Fitz-Gerald writes: Many investors dream of making the "big trade."

Spurred on by stories of fabled investors who accumulated generations of wealth with just one big trade, they talk incessantly about what they could or should have done.


But actually doing something about it pays better.

Consider George Soros, who reportedly made $1.1 billion in a single trade against the Bank of England by shorting the British pound on September 16, 1992. Or Jessie Livermore, who reportedly made $100 million on October 24, 1929 - Black Thursday. Or how about Jay Gould, who tried to corner the gold market on September 24, 1869. Nobody knows exactly how much Gould made but he left his children $77 million when he died in 1892.

Well, if you have the guts, now is the time to make your move, because I think the next "big short" is already out there. In fact, judging from open interest I'm seeing on gold puts and VIX puts, I'd bet on it.

Right now there are literally tens of thousands of contracts open on both at various strike prices, so the odds are good that somebody - perhaps a group, a hedge fund, or another big money player - is placing highly leveraged bets that things will reverse.

With the proper structure, these trades could dwarf the bets made by Soros, Livermore, and Gould.

Certainly, all of the conditions are there.

We've had several days of pure panic buying. Gold prices are up 25% so far this year and up 90% in the past two years.

The public is buying and, late night commercials aside, it's clamoring for gold in a way that makes me nervous. Meanwhile, politicians in Washington actually believe they understand the risks associated with credit default swaps and sovereign debt - and that practically guarantees that they don't.

But what really gets my attention, and gets my greed glands going, is that Washington is now going to "do something." As if the government hasn't already "done" enough.

That means another bailout or stimulus is imminent. It also suggests that there will be a corresponding sigh of relief, a decline in volatility and a drop in gold prices.

Then all hell will truly break lose.

But that won't matter because the damage will already have been done and the profits will already have been banked. Book deals will have been struck and we'll have a whole new generation of motor mouths at the country club who talk about how "they could have made the trade, too, if only..."

If you want to play along, here's what to do.

•Buy out-of-the-money SPDR Gold Trust (GLD) put options. Because you are buying them, your risk is limited only to what you spend to purchase them.
•And buy out-of-the-money iPath S&P 500 VIX Short-Term Futures (VXX) put options. Here, too, your risk is limited because you are buying the options rather than selling them.

But remember, DO NOT invest money you cannot afford to lose completely. Nothing is guaranteed.

Soros, Livermore, Gould and Paulson knew what they were doing when they placed their bets and were prepared for the consequences. You should be, too.

Source :http://moneymorning.com/2011/08/12/a-potential-big-trade-that-will-put-george-soros-to-shame/

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