Crude oil futures shot up by $3.70 a barrel

As I type, Egypt is on the brink.

Egyptian president Hosni Mubarak has ordered tanks out on the streets of Cairo. And F-16 fighter jets are roaring over the heads of the tens of thousands of protesters that are calling for an end to Mubarak’s rule.

This is a game-changing event. Not just politically, but for the markets too.

On Friday, we saw a big sell-off in stock markets around the world. And this morning we’ve seen some more sharp losses in Japan, Australia and Hong Kong.

Meanwhile, crude oil futures shot up by $3.70 a barrel. Oil investors are worried that we may see the closure of the Suez Canal, through which about 1% of global oil production pass through each year.

Traders are also worried that unrest in Egypt could spread to oil rich Arab states such as Saudi Arabia.

Oil is headline news right now. And rightly so. If we really are seeing the start of a big dislocation of power in the Arab world, oil prices could soar from here.

But there’s another trade that is gathering momentum – one that I wrote about just over a week ago here at International Living Investor.

I’m talking about rising volatility.

When traders and investors talk about volatility, what they mean is how much market prices are likely to swing up and down. The bigger the price swings the greater the volatility.

We can measure market volatility through an index called the VIX – what’s commonly referred to as the “investor fear gauge” because it rises as investors’ expectations of higher volatility rise.

How the VIX tracks expectations of volatility involves calculations based on options prices and is quite complex. What’s important is that the more worried investors are about the future, the higher the VIX rises.

On Friday, as angry protesters gathered on the streets of Cairo, Alexandria and Suez, the VIX spiked. You can see this in the chart below of a one-month snapshot of the VIX.

You can “buy the VIX” with shares of the iPath S&P 500 VIX Short-Term Futures ETN (NYSE:VXX). This is an exchange-traded note—or ETN— that rises as the VIX rises.

Simply put, ETNs are differently structured to ETFs. But their purpose is the same: to give investors a low-cost way of tracking certain market sectors or indexes.

As I pointed out recently, VXX has been a great buy because it’s reached extreme lows. That means the upside potential is huge and the downside is limited.

These are the type of trades that you want to get into—trades that are unpopular with the mainstream…trades you have all to yourself.

The spike you saw on the chart above represents an 8% move on the VXX in a single day. If we don’t see some sort of resolution in Egypt soon, I expect more gains in VXX this week.

The risk/reward ratio of this trade is heavily skewed toward the reward side of the equation. That makes it a trade with great upside potential right now.