Considering Our Options – $VIX Portfolio Protection

by CC December 27, 2013 1:42 pm • Commentary

Just after the latest FOMC meeting we re-initiated our go to VIX portfolio protection trade with the spot VIX around 13.33. Since then the market has done nothing but rally and the spot VIX has fallen at one point below 12, and now sits at about 12.50. With the slow weeks of the Holidays upon us an the New Year right around the corner it’s a good time to re-visit the trade and look at its risk reward profile and possible trade management into January. To recap, here’s the trade:

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

With the VIX at 12.50, the Jan futures around 14.50 and the Feb futures about 15.50 this structure is about 45c in the hole mark to market. It’s not much of a worry at this point due to time to expiration and the fact that a falling VIX into the end of the year is quite normal. In hindsight we could have waited closet to the holidays to initiate the trade for a better entry but the worry at the time was missing the post FOMC vol collapse lows which usually occur just days after the event.

The VIX bounced this week off of what looked to be pretty worry free lows, which makes sense with the market at new highs on a breakout as investors will look for a little protection in the form of puts when in new territory. The key for this trade will be management in January in case we do see a good start in the market in the first few weeks of the new year. We’ll still have the Feb debt ceiling loose ends to clean up, as well as the FOMC meeting at the end of January. What that means is vol should pick up into the end of January, even if the market starts off the year strong.

The only thing that would make us close the trade early is if those issues start to be telegraphed early and any uncertainty from Congress or the Fed starts to abate. But that really hasn’t been the case lately, and we should see at least a run back towards 16 again at some point in the next 2 months, and any real uncertainty that causes a pullback in the markets would make the trade a nice winner. So we’re comfortable with the structure for now, although we could have gotten a better entry this cycle.