VIX: Low Premium Way to Take Advantage of Abnormally Steep Term Structure

by Dan March 13, 2012 11:52 am • Commentary

The VIX is melting, trading at 14.63, down about 30% a week.  This sort of price action on any sort of trade-able security/index catches my attention.  The chart below shows the massive divergence btwn the SPX and the VIX, and the chart below shows how this relationship topped out last May when both indices were at similar levels.  

[caption id="attachment_9524" align="aligncenter" width="300" caption="VIX vs SPX 1 Yr."][/caption]


The chart below shows the steep Term Structure in the VIX Futures as we see prices of north of 20 starting next month in April, and as high as 28 in Nov.  The steepness of the term structure is about 2x the normal levels.  In a quiet market we would expect to see VIX futures to be in contango since current volatility is low, this steep of a term structure is still out of the ordinary, indicating the fear of unexpected future events.

[caption id="attachment_9525" align="aligncenter" width="300" caption="VIX Futures Term Structure from Bloomberg"][/caption]


This short term anomaly presents an interesting short term trade with March VIX options expiring next Wednesday the 21st of March on the close, I can get at the money exposure for a short term pop in volatility for low premium by selling an April call 45% above current Apr vix future levels

TRADE: VIX ($14.63) Bought the March21st 17 / April18th  17 / 30 Diagonal Call Spread for .15

-Bought the March 17 Call for 1.04

-Sold the April 30 Call at .89

Break-Even On March 21st:

If VIX is below 17 the calls you own in March expire worthless and you will need to cover your short April 30 call, or create a call spread by buying a lower strike call.

If the VIX is above 17, you will make the difference btwn the call that you own and the current spot price, less the difference in price of the April 30 call that you are short.