Ricks Picks

Why VXX Is a Sucker Bet


The late John Scarne, one of the world great experts on gambling, once wrote a treatise explaining why you can’t win at three-card monte. That’s the game where a grifter lays three playing cards on a makeshift table, instructing you to follow the queen. He turns them face-down, flipping the queen over now and then to make it easier for you to keep track. Sure enough, you pick the lady correctly a few times and win $20, $50, or even $100. “Hey, you’re pretty good at this,” the con-man says. “Want to raise your bet to $200?” And so you do, eagerly, after noticing something you hadn’t spotted earlier — i.e., that the queen has a slightly bent corner that makes it easy to know where she is at all times. The “broad-tosser” flips the cards around a few more times with some deft flourishes that are impossible to follow. But what do you care? There’s the bent card in the middle, and so you jump on his offer to double your bet yet again, to $400. You plunk down two more benjamins, tap the middle card as your choice, only to discover when he turns it face-up, bent corner and all, that it is NOT the queen. You would need to have read Scarne’s treatise to understand how the grifter, on his final toss, deftly unbent the corner of the queen and bent the corner of one of the other two cards in a nanosecond.

These days, the three-card monte artiste is more likely to turn up as a put-and-call trader taking the other side of sucker bets such as the one shown in the chart. Why risk getting busted on the street by some beat cop when securities exchanges make rules and create products that make it possible to fleece rubes without leaving your house? No better vehicle could be conceived for this purpose than the VXX, an index that tracks short-term S&P 500 volatility. It offers one of the most seductive bets in the stock-market world, but the operators taking the other side are using a deck so heavily stacked in their favor that you literally can’t win.

A Pittance for Genius

Sure, you’ll occasionally hit a winner that doubles your stake. The charts show one such opportunity that occurred this week. The left-hand graph is of the VXX while the other shows near-term call options with an exercise price of 30. The dramatic selloff of the last few days caused VXX to spike nearly 40%, from 21.5 to 29.5. If you’d seen it coming and bought the options for, say, 0.55 just before they took off, you could have sold them for as much as 1.60. In actuality, only a handful of contracts traded at that height, and even a demon-genius trader would have been challenged to exit for 1.20, doubling his or her money after commissions. But the trader would have waited for nearly two months for the opportunity to make that $105, presumably frittering away $200-$300 in the process. That’s the way the game typically works, and although it looks as easy as scattering five milk cartons on the carnival midway, you should be aware that even a Category Five hurricane could not knock down one of those cartons that has been specially modified.

Rick’s Picks nonetheless offers occasional VXX bets, but only when the index is bottoming precisely at a Hidden Pivot target. In this case, we might have bought some calls if it had touched 21.03, but it never got below 21.41. And even if we had done the trade and doubled our money, we might wait for another 4-6 months for another such opportunity. That’s why we never make VXX bets unless there’s a chance to quadruple our stake or better. Even then, outcomes will compare to betting on 40-to-1 horses all the time. Winning can be fun when it happens, but even the smartest players shouldn’t hope to make a living at it.

Comments on this entry are closed.

Thomas White August 7, 2019, 2:16 am

This is a superbly written piece. Very interesting.

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