We think investors the world over are entirely too complacent for the for the following reasons (to name just a few):
1) U.S. macro growth data continues to come in weaker each month, which is catching up to already weak international growth data
2) U.S. earnings and revenue estimates have been revised lower at the fastest rate since the bull market began in 2009, an obvious sign that macro starting to affect micro
3) European risks are still present, evidenced by Spanish and Italian sovereign yields above 6%, and European banks only 5% from this year’s lows
Below is the 1 yr chart of the VIX vs the SPX, and while there is nothing scientific here, a few times this year when the SPX neared upside resistance and the VIX was hitting downside support this was a decent opportunity to play for downward move in the SPX, and an upward spike in the VIX.
We obviously have the short Equity trade covered, but to make a near term bet that vol is just a bit too low, we want to buy calls, or call spreads in the VIX in August.
TRADE: VIX ($16.10) Bought Aug 20/25 Call Spread for .75
-Bought 1 Aug 20 call for 1.52
-Sold 1 Aug 25 Call at .77
Break-Even on Aug Expiration (Aug 22nd, not equity options expiration Aug 18th):
-Profits btwn 20.75 and 25 of up to 4.25, with max gain of 4.25 above 25.
-Losses of up to .75 btwn 20.75 and 20, and max loss of .75 below $20.
Trade Rationale:
CC, Enis and I all collaborated on this trade. Enis bought the Aug 19 calls outright for ~1.70 with an eye towards legging into a Put Spread on a spike in vol. I liked taking advantage of the upside skew out of the gate by selling a higher strike Call, which gives me a lower break-even, but reduces my profit potential. This is a medium term conviction idea, and I will likely average in a bit, but we are all in agreement that the almost 3.5% move higher in the SPX since Thursday’s lows as we head into the meat of earnings seasons with little concern for issues in Europe could make this a great time to make this bet.
As a quick aside, trading the VIX takes some patience and I always place bids or offers mid market and usually get done there, we rarely pay full bid ask. Also we are not fans of trading VXX or options on the name, as the “carry” on the etf puts you at a massive disadvantage.