New Trade May 15, 2013: I just wrote about the VIX in my Snapshot post from today, included below. I also traded a VIX structure last month, targeting May VIX, which I plan to leave on for now, but might adjust between now and next week’s VIX expiry.
In the meantime though, I want to give myself more exposure through a long VIX structure in June futures. I like the risk/reward in long VIX positions because of the asymmetric risk/reward here with a market making emotional new highs each day, and increased volatility in other asset classes like commodities and currencies. Here’s the trade:
TRADE: Sold the VIX (12.87) June 14/12 Put Spread to Buy the June 16 / 20 Call Spread, Even Money
-Bought 1 June 12 Put for 0.08
-Sold 1 June 14 Put at 0.73
-Bought 1 June 16 Call for 1.23
-Sold 1 June 20 call at 0.58
Break-Even on June Expiration:
-Profits up to 4 between 16 and 20, max profit of 4 at 20 or above
-No profit or loss between 14 and 16, structure expires
-Losses of up to 2 between 12 and 14, max loss of 2 at 12 or below
While the risk/reward looks like I’m risking 2 to make 4, I actually view the risk of VIX moving below 12 as quite low. In any case, I hope to take this structure off on the first spike higher in the VIX, which should be a nice mark-to-market gain if the VIX reaches the high teens. Rather than trying to time the market turn, I would rather own a long VIX structure that will do well on the first major vol spike, which I think is likely given the emotional nature of this market.
VIX Futures Snapshot May 15, 2013:
I’ve received many questions in the past 24 hours about why the VIX is going up even as the SPX index continues to make new all-time highs. Here is what I wrote last month in my VIX trade post about volatility on assets making new all-time highs:
With the SPX index making all-time highs, VIX spot has moved back to near the 12 level. However, a new all-time high can sometimes be a reason for increased volatility rather than just decreased volatility,a case we laid out for our IBM trade idea last month. In that post, Enis said:
When stocks make new breakouts like this, options oftentimes get bid up as traders prefer to own options to play for a fast move on the breakout rather than buy stock and risk a false breakout scenario. In that sense, IBM’s breakout to new all-time highs presents a likely either/or scenario. EITHER IBM’s breakout holds and the stock continues its march higher like the previous instances in the past 3 years. OR IBM’s breakout today is a false breakout, and IBM breaks back below the prior 212 resistance level, faking out all the new buyers who bought the breakout today.
In either case, this type of setup is conducive to a fast move in either direction. It’s rare that IBM’s stock just sits right above the breakout level. So are option prices expensive as a result?
The same holds true of the SPX index today. Even if the breakout continues, we expect that there will be a sharp selloff at some point in the next couple months simply because the steepness of the ascent signals a more emotional rally. With the VIX at 12, near the lows of the year, the entry for a long VIX related trade is decent:
Sure enough, new all-time highs in the SPX index have resulted in an almost 100 point move higher since that breakout. The move’s velocity has picked up in the last week, which is causing volatility traders to re-assess the low pricing of options. Buyers of protection are also likely getting more aggressive as prices advance so aggressively.
To get a sense of how the VIX futures have moved, here is last week’s snapshot:
Compare that to today’s snapshot:
So VIX spot is higher, and the May VIX future is the only futures contract that is lower. All of the other futures are higher in the past week, despite the 40 point move higher in the SPX index since last Wednesday.
I expect the VIX to remain elevated from here whether the SPX continues higher or corrects lower. To me, the low probability event is for the market to consolidate around here in a tight range for the next few weeks, which is what is implied by a VIX at 13. We are in uncharted territory for the SPX index, and I expect option prices to rise in anticipation of more large moves.