As 2012 came to an end, we saw a spike in volatility, as was evident with VIX moving above the 20 mark. Now that we have started the New Year, and a deal has been reached on the fiscal cliff a lot of volatility has been removed from the market, and as a result VIX has fallen, and is currently sitting at 14.34.
While it is encouraging to see VIX moving lower, I believe this will be short lived, and expect to see another spike in volatility as focus is quickly shifting to the debt ceiling debate.
The last time Washington tried to deal with the debt ceiling was back in the summer of 2011, and during that time we saw VIX spike all the way up above 45, and there is no reason why we should not expect to see another bounce during this round of negotiations.
The reasoning is pretty simple. While the fiscal cliff headlines spread fears of another recession, the headlines we will see in the months ahead will much more dire. It's one thing to fall into a recession, but it’s a completely different thing to hear that the country is not going to be able to pay its debts.
We will hear of all the government employees that will not get their paychecks, and we may even see another downgrading of the nation's credit rating.
The worst is far from behind us. If Washington has proven anything over recent years, it is that the Republicans and Democrats are so far apart than any meaningful negotiations are going to be very slow, and very little will be agreed upon.
I expect that, as we saw with the fiscal cliff and the 2011 debt ceiling debate, that a new deal will be reached on their current debt ceiling, but it will most likely come down to the last minute. The longer the debate lingers the higher the volatility that we will see. It is not out of the question to imagine VIX will head to the 40 level again before it is all said and done.
One way to benefit on the expected volatility would be to buy some calls on VIX. VIX is currently sitting at 14.32, and we expect to see it trade well above 20 as the debt ceiling headlines start to spook investors, so we would look to buy some April 20 calls.
With the recent drop we have seen in VIX, now is the perfect time to buy some calls before it starts to tick up again.