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The Best Ways to Profit From the Dow's Volatility

Dan Caplinger
October 9, 2013

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Few things are certain in the investing world, but one rule almost always holds true: Nervous investors don't like to buy stocks. The government shutdown has put investors on high alert, with the Dow Jones Industrials (INDEX: ^DJI) having given up 900 points in less than a month as Wall Street and Main Street alike consider the impact of the government shutdown and the debt-ceiling impasse on the economy and their investments. The Dow's choppiness today has been characteristic of market moves lately, with the Dow trading near the unchanged level as of noon EDT after moving both upward and downward earlier in the session.

In times of trouble, attention moves to the so-called Fear Index. The S&P Volatility Index (INDEX: ^VIX) was up another 1.2% as of noon, briefly hitting levels seen on just two occasions in the past year: following the June Federal Reserve announcement concerning possible QE tapering and during the fiscal-cliff crisis.

Astute investors always wonder whether there are ways to profit from volatility. That demand is the key reason why financial institutions created volatility exchange-traded products. Volatility-trackers like the iPath S&P 500 VIX ST Futures ETN (NYSEMKT: VXX) have become immensely popular, and as you'd expect, they tend to perform well in times of trouble. This iPath ETN has climbed more than 25% just since the last week of September, while its leveraged peer, the VelocityShares Daily 2x VIX ST ETN (NYSEMKT: TVIX), has jumped 50% in the same time frame.

These investments give their shareholders exposure to the moves in volatility futures contracts, which themselves are fairly complex derivative secur