Considering Our Options – $VIX Sept Call Spread Risk Reversal

by CC September 17, 2013 2:26 pm • Commentary

Sept VIX futures expire tomorrow morning. I wanted to take a quicl look at the VIX structure that we put on back on Aug 22nd (below).  Barring some unforeseen event overnight it will most likely expire as a wash as we put it on for even money, but to quickly refresh, here was the trade:

TRADE: Sold the VIX (14.70) Sept 14 Put to Buy the Sept 17/20 Call Spread for Even Money

-Sold 1 VIX Sept 14 Put at 0.44

-Bought 1 Sept 17 Call for 1.06

-Sold 1 Sept 20 call at 0.62


The rationale behind this trade was to get long volatility exposure for this past month knowing that the likelihood of it expiring below our put strike was very low. That risk was very low for a number of reasons but most importantly was the fact that expiration was due to fall on the morning of a FOMC day. You can see in the action of the VIX over the past few days and weeks as the market has gone higher, it refuses to break down completely. It’s a Bernanke bid with the timing of the event. Today, the market is up solidly and the VIX is higher on the day.

In hindsight we could have taken the trade off for a profit of about 50 to 70 cents at its best moment. We liked the exposure at the time though. After the FOMC, expect the VIX to get hit pretty hard unless the market does as well. If the market goes higher or sideways and we see that VIX crash, look for us to put on a similar structure farther out in case of a reversal after new SPX highs.



New Trade $VIX – Benny and VIX Septs

10:43 AM EDT – AUGUST 22, 2013 BY  (EDIT)

I laid out the heavy central bank calendar over the coming month in yesterday’s Macro Wrap.  Clearly, this market has more event risk over the next month that could drive volatility similar to what we saw yesterday.

So we’ve been poking around for long VIX structures that are attractive risk/reward with little premium outlay.  Particularly since the VIX is still around 15, which, as I explained in my post last week, might be cheaper than it looks at first glance.  We’ve settled on a structure that looks exceptional given the circumstances surrounding the VIX next month.

The VIX expiry falls on the morning of the FOMC September announcement (and Bernanke press conference).  As a result, the actual press release won’t be until later that day, after the VIX will already have expired.  So options traders are likely to remain bid for SPX options on that morning of VIX expiry, which makes us think that VIX expiry will not be a very low print, no matter how quiet the market remains going into the event.  In other words, the Sept 18th FOMC release is the most important Fed meeting in 2013, so options are likely to remain bid ahead of it.

All of that means that we are happy to sell the VIX downside puts in September given the lower than normal probability of a low VIX print.  We can use that premium to buy a VIX call spread in September in case the market’s jitters become more substantial in the coming weeks:

TRADE: Sold the VIX (14.70) Sept 14 Put to Buy the Sept 17/20 Call Spread for Even Money

-Sold 1 VIX Sept 14 Put at 0.44

-Bought 1 Sept 17 Call for 1.06

-Sold 1 Sept 20 call at 0.62

Break-Even on Sept Expiration:

-Profits up to 3.00 between 17 and 20, max profit of 3.00 at 20 or above

-No profit or loss between 14 and 17, structure expires

-Losses below 14 in linear fashion

Trade Rationale:

We normally are adverse to selling outright puts, but the nature of this VIX settlement falling on the morning before the FOMC release makes us much more comfortable taking that risk.  As a result, we like the risk/reward of this structure.  For those who have margin concerns, you could sell the Sept 14/12 put spread instead of the Sept 14 put outright. That structure only costs an extra 5c, so it can be put on for even without the margin issue.

As far as risk reward goes, this trade on paper is one that is risking 2 to make 3. But we think the nature of the VIX (downside risk is not to zero, more like 12) combined with the Fed uncertainty and timing of the expiration date on a FOMC day makes for a trade that is probably more like risking 1 to make 3. The most likely result of this trade is that the VIX expires in the middle of our strikes (worthless) and we collect 5c. On paper, the up and down scenarios are probably equally likely. But since the upside is more reward than the downside is risk, and we think the Fed keeps the VIX bid, we like this entry.