New Portfolio Protection Trade $VIX – Groundhog Play

by Enis December 19, 2013 11:35 am • Commentary

Buyers of portfolio protection in 2013 have seen their option premiums evaporate for much of the past 18 months.  The S&P 500 has not had a correction of 10% or more in that period, quite a run for the index.  As a result, put spreads, collars, or other downside structures have generally hurt overall portfolio returns.

In such an environment, the VIX has become our favored method of portfolio protection.   Our last 3 VIX trades (taken off in Sept, Oct, and Dec) were either flat or winners, despite the fact that the SPX has continued to march higher during that period.

We have relied on 2 broad factors when structuring such VIX positions:  

1)  What does the event calendar look like?

In both our Sept and Dec trades, we benefitted from the fact that the FOMC decision was on the day of VIX expiry (a Wednesday), which kept VIX spot elevated even as the SPX traded near all-time highs ahead of the event (and in both cases, after the event).  For our Oct VIX structure, we anticipated the political impasse that was coming to a head in early October, and picked October expiry for that reason.

2)  Does the VIX entry and structure offer asymmetric risk/reward?

Each time we have traded the VIX over the last 6 months, we have done so by selling a downside put or put spread, mainly because we view the possibility of a VIX below 12 as quite unlikely as long as the S&P 500 is continuing to make new all-time highs (for more background on that discussion, see this post).  With that in mind, we like selling the downside put to buy a call spread in the VIX as a low risk way to get some protection.

In early 2014, the 2 key macro events in the U.S. are the FOMC release on January 31st and the debt ceiling debate set to take place in Washington, D.C. in early February.  With that calendar in mind, and VIX spot back near the lows of 2013, we like the following structure here today:

TRADE: Sold the VIX (13.33) Feb 14 Put to Buy the Feb 16/20 Call Spread for Even Money

-Sold 1 VIX Feb 14 Put at 0.65

-Bought 1 Feb 16 Call for 1.40

-Sold 1 Feb 20 call at 0.75

Break-Even on Feb Expiration:

-Profits up to 4.00 between 16 and 20, max profit of 4.00 at 20 or above

-No profit or loss between 14 and 16, structure expires

-Losses below 14 in linear fashion

Trade Rationale:

As we’ve mentioned with regards to this structure before, if you do not have the margin capability to sell the Feb 14 put on its own, you could also adjust the structure to selling the Feb 14/12 put spread, though you do have to pay a bit of premium in that case but it may be worth it to not have margin tied up.  We would target taking this trade off sometime in late January or early February, before all of the potential events are resolved or on any spike in volatility between now and then.