Trade Update w/ New Trade – VIX: Spot VIX at 5 Yr Lows Warrants Action

by Dan August 17, 2012 1:38 pm • Commentary

Update and New Trade Aug 17th, 2012: Back in mid July when the spot VIX was testing the March lows at the previous market top, Enis and I both wanted to buy short dated calls in anticipation of an expected Vol Spike in Aug.  Well we got one in late July which saw the VIX trade for a few sessions above 20, only to spend the next few weeks melting to today’s 5 year lows.  I had an opportunity to take profits on my Aug 20/25 Call Spread for more than a double, but I got a little greedy as I thought we would revert back above the long term mean as global macro fears gripped world markets.  Well that obviously didn’t happen and the premium of my spread has been eviscerated.   

I think there is a good shot we see some fireworks in the weeks to come as Bernanke not likely to hint o QE in Jackson Hole, and not likely to act at their Sept 13 FOMC meeting.  When European leaders and Central Bankers get back from Holidays I assume they will start saying and acting stupid again and whatever data we see out of China is likely to continue to suck.  SO we have a little bit of a “Goldilocks” period for equities (except for China), It is my view that the relative calm exhibited this month will be met with some sanity in the weeks to come.

With just 2 trading sessions to Aug VIX expiration I am going to roll this view to Sept19th VIX expiration.One by two call spreads look very attractive as you can get out of the money Sept call spreads on for no cost, but we think in the event of a massive spike in Vol this is not an appropriate risk/reward proposition for most retail investors, which leads us to ButterFlies.

NEW TRADE: VIX (13.55) Bought the Sept 20/25/30 Call Butterfly for .45*

– Bought 1 VIX Sept 20 Call for  1.51

-Sold 2 VIX Sept 25 Calls at .74 for a total of 1.48

– Bought 1 VIX Sept 30 Call for .42

* the bid ask is very wide here, screens were .30 at .60 and I got filled with a .45 limit mid market.  This is not a product to ever use market orders.


Break-Even on Sept19th Expiration:

-Profits Btwn 20.45 and 29.55, make up to 4.55 with max gain at 25 of 4.55.

-Losses of up to .45 btwn 20 and 20.45 and btwn 29.55 and 30, with max loss of .45 above 30 and below 20.


TRADE RATIONALE: Please see the reasons from last month’s trade below, they haven’t changed. We felt that the market was way to complacent then, and obviously still do. But, the longer the complacency lasts, the less likely it is to persist much longer, in my opinion.  I also updated the chart of the SPX vs VIX over the 2 last years, the inverse relationship is blowing out.  I think this is a great spot to once again take this view.

[caption id="attachment_15724" align="aligncenter" width="490" caption="2 yr SPX vs VIX from Bloomberg"][/caption]




Original Post July 18th, 2012:  New Trade VIX: Spot VIX With a 16 Handle is Rubbing Us The Wrong Way

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.