Volatility Is Set To Spike -- Here's What To Do

Highs and Lows Stock Data

When I first began my career at the Chicago Board of Trade, I felt like a newly hatched alligator being released into the wild. I was swimming around much bigger and more experienced animals that wanted to turn me into a quick lunch and take me out of the game.

In that ultra-cutthroat environment, where I competed against Goldman Sachs and billion-dollar hedge funds every day, I had very little time to develop my trading technique and confidence.

When studying my fellow traders and developing my style, I noticed something important right away. Some groups of traders would make money when the market was trending in one direction. On the flip side, there were other groups of traders that would make money when the market was range bound.

Few traders could switch hats on a day-to-day basis and play both kinds of markets. Those who could were the real masters of trading.

Seeing this pattern of different trading styles winning in certain kinds of markets year after year provided a valuable lesson about trading and investing.

It taught me that every trader, or trading system, can be profitable in some markets. But no trader, or trading system, will be profitable in every market.

This basic principal that I uncovered more than a decade ago also applies to the approach I use in my premium options income service, Income Multiplier .

My subscribers and I have had an incredible run in the last two years. Since launching in March 2014, we've been able to close almost 100 winning trades, with no closed losers.

The system itself deserves some of the credit. To put it simply, we use a conservative put option strategy to generate income from only the most stable S&P 500 companies that are paying dividends, repurchasing shares and are undervalued.

However, the market deserves just as much credit. For the last two years, we've had ideal conditions for the Income Multiplier strategy . The S&P 500 has been mostly range bound, with three short-lived declines never exceeding more than 13%. Take a look below.

For the last two years, we've had an ideal market for the Income Multiplier with a range-bound S&P 500.

Those declines were good for the system because the so-called "fear index," or VIX, spiked, making it more valuable to sell puts.

That's why we were able to close some of the biggest winners we've ever seen in March after selling puts in January and February when the market was down and the VIX was spiking.

But no system is perfect. I learned that the hard way during my days as a trader in Chicago, and that's why I'm recommending my readers exercise caution right now.

If the S&P 500 were to suddenly fall into a bear market, we could conceivably take assignment on every single open position in the portfolio. If one of my subscribers were to make the mistake of selling too many puts, thinking the fantastic run we've had will never come to an end, this could lead to some big losses that could obliterate their account.

This lesson in risk management is particularly relevant right now for two reasons.

For one, the time period between May and October is an historically weak time for the S&P 500.

Second, the VIX is currently trading near a two-year low. Take a look below.

I'm not predicting a crash or even a bear market. But I do expect the VIX to spike at some point in the next few months. When that happens, stocks will fall and some of our trades will most likely fall into the red.

We need to hope for the best but always prepare for the worst.

That's why I'm recommending that my Income Multiplier subscribers double down on risk management this week. As I mentioned before, we've had a great run, but you can never be too careful.

Whether you use my income-generating options strategy or not, I advise you to do the same.

If I'm right and the VIX does spike, then the market will fall, and you will feel the pain. I don't mean to sound alarmist -- there's still plenty of money to be made in this market. But now is the time to be prepared and disciplined. And with the market still trading strong, we have plenty of time right now to right-size any open positions.

P.S. If you haven't considered using options for income before, I'd encourage you to give it a try. The income you generate can help offset any weakness you might experience in the rest of your portfolio. When done properly, as our track record shows , the results can be remarkably consistent. To learn more about how my Income Multiplier strategy works, go here .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

© Copyright 2001-2016 StreetAuthority, LLC. All Rights Reserved.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Street Authority

Founded in 2001 by industry veterans, StreetAuthority is a financial research and publishing division of Investing Daily. Our mission is to help individual investors earn above-average profits by providing a source of independent, unbiased — and most of all, profitable — investing ideas. Unlike traditional publishers, StreetAuthority doesn’t simply regurgitate the latest stock market news. Instead, we provide in-depth research, plus specific investment ideas and immediate action to take based on the latest market events.

Learn More