VIX spot has been stuck between 13 and 15 for much of the past 3 weeks. In that period, we’ve received a number of questions about whether we were looking at a long VIX options structure to play for increased volatility in the coming months.
Our Name That Trade post from early April discussed our views on a potential VIX options trade to play for a move higher in VIX futures:
We have had success over the past 6 months with long VIX structures that we initiated when VIX futures fell to the 13-14.50 area (most recently on this trade). However, we have been watching the VIX term structure closely over the last week, in anticipation of re-entering that sort of structure, and VIX futures have been stubbornly strong, even on days like yesterday when the S&P 500 tested or made a new all-time high.
Since then, we have continued to watch VIX futures and options, and have not seen a good risk/reward options structure that we wanted to trade. A big reason why we were more active in VIX options last year compared to 2014 is that the skew in VIX options has changed (perhaps as market makers re-priced options to eliminate what we viewed as very good risk/reward structures).
Let me explain. Our main structure in 2013 was to sell a put and buy a call spread in VIX, preferably for an expiration that was close to an important macro event or catalyst (FOMC, or debt ceiling discussions in the fall, etc.), so that VIX spot was unlikely to settle much below our short put strike. That worked out quite well, as the settlement print for the VIX always ended up above our put strike, and our structures were generally for no premium, meaning a scratch was our worst outcome on several such trades, with a few decent winners when VIX spiked and we sold the call spread.
In 2014, however, the 14 put that we usually sold last year has hardly been bid (for example, the June 14 put is currently 0.35 bid), so it has not been worth it to sell the downside. Without selling the put, we have not wanted to spend outright premium to buy a VIX upside call spread, given the propensity for that structure to expire worthless if nothing happens.
Here is a chart of the difference between the implied volatility of the at-the-money strike in the VIX vs. the 120% strike in the VIX (both 3 months out):
As you can see, the upside skew is at a 5 year high. Part of this is because the absolute level of the VIX is low. Regardless, it has become unattractive to sell at-the-money or downside options in the VIX, and buy upside options.
Also, the overall level of implied volatility on the VIX is also near a 5 year low, which has also made selling a put and buying a call spread on the VIX less appealing. These are the reasons why our 2013 VIX structure hasn’t made sense in 2014.
We continue to look at other structures that may fit the bill for the new skew environment. One of those structures would be an in-the-money call spread, out a few months, with a realistic breakeven that would only need one pop in the VIX between initiating the trade and its expiration. Alot of those spreads have current break-evens in the 16 range which seems quite safe as far as looking out a few months. We’re likely to look to that sort of structure or something similar when we do make a move.