We have received a number of questions about our VIX structure that expires tomorrow morning (all VIX options expire as cash settlement on the opening settlement price on the morning of expiry). Here was the original trade:
TRADE – Sell the VIX (12.10) June 14 put and buy the June 15/19 call spread for 5c
– Sell 1 June 14 put at .55
– Buy 1 June 15 call for 1.00
– Sell 1 June 19 call at .40
…
Having said that, the reason why we like the June structure is that VIX expiration is on the morning of June FOMC meeting, which will likely prevent the VIX settlement print to be too far below 14 with that event on the horizon. A pop in the VIX into the high teens would be where we would likely look to take off the trade.
Since then, VIX futures in June have steadily declined (though VIX spot is actually up a touch since May 13th). We have said for the past couple of weeks that we would prefer to hold the short June 14 VIX put until expiration rather than close it out beforehand because of the FOMC meeting tomorrow morning.
The VIX has had some interesting expiration settlements over the past year, most of which were higher than expected, which is the main reason why we have preferred to wait for the cash settlement rather than close out the June 14 put for between 1.30 and 2.00 over the past couple of weeks.
The way the cash settlement works is the same as taking the loss or gain on the structure. In this case it’s very likely that this structure will settle as a loss. We’d prefer that option at this point than closing it because of the possibility of a spike on the settlement price tomorrow morning plus the lack of commissions involved as opposed to closing the structure for a loss today (here is a similar trade from last September that expired cash settlement for no loss).
This is a structure we continue to like despite it looking like it won’t work this time around. We feel there is very little risk compared to the potential reward, and even though this one is likely to settle at a loss, we consider it cheap portfolio protection and a good bet that ran into extraordinarily low vol this time around.
New Trade – VIX on Vapors
The other day we wrote (below) about the VIX and how the options were frustrating us even as the spot VIX moved towards new lows on the year. We said that for various reasons, the options were not allowing us to do our preferred structure and we may need to look to a different one with a slightly different risk profile.
However, with the new high in the market today and a new low in the VIX , the VIX futures and options on those futures have finally cooperated, allowing us to do our preferred trade for close to even:
TRADE – Sell the VIX (12.10) June 14 put and buy the June 15/19 call spread for 5c
– Sell 1 June 14 put at .55
– Buy 1 June 15 call for 1.00
– Sell 1 June 19 call at .40
Break-Even on June Expiration:
-Profits up to 4.00 between 15 and 19, max profit of 4.00 at 19 or above
-No profit or loss between 14 and 15, 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 June 14 put on its own, you could also adjust the structure to selling the June 14/12 put spread, though you do have to pay a bit of premium in that case, but your potential loss is limited to $2. Having said that, the reason why we like the June structure is that VIX expiration is on the morning of June FOMC meeting, which will likely prevent the VIX settlement print to be too far below 14 with that event on the horizon. A pop in the VIX into the high teens would be where we would likely look to take off the trade.
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Checking in on the VIX
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.